Money Mensch: These really are the ISAs on the cake
While ISA (individual savings accounts) rates have had a justifiably bad press recently, they still vastly out-pay the best savings accounts. My aim is to ensure you know what you are doing.
● The Basics
Imagine you have got a couple of cakes: one chocolate (representing cash) and the other strawberry (shares). Now picture the taxman picking up a slice and taking a bite. Yet each year, to encourage saving, you're given a tax-free ISA wrapper, a bit like cling film, that you can put around some of the cake. Once inside the cling film, the cake does not change. The chocolate is still chocolate (cash is still cash) and the strawberry is still strawberry (shares are still shares). The only difference is that, once inside the ISA, the tax man can't bite it.
● How do cash ISAs work?
The cash element of ISAs is simply a tax-free savings account, and you can take your money out whenever you want. This year, everyone will be allowed to put £5,100 in one - and, importantly, once the money's in, it stays tax-free.
Normally, basic rate taxpayers hand over 20 per cent of their savings interest to the taxman (higher rate taxpayers 40 per cent), so keeping cash in an ISA boosts your take-home interest by a quarter (two thirds for higher rate taxpayers) and this gain compounds each year. The problem is many providers gleefully take this gain for themselves by offering desultory low rates like 0.1 per cent. Yet you can avoid that.
The Top Paying Cash ISAs
● Top Easy Access Deals - 3.2 per cent with rate guarantee. The current easy-access best buys are sister banks Alliance & Leicester and Santander, whose Flexible Cash ISAs pays 3.2 per cent AER and guarantees to be 2.7 per cent points above base rate for the first year. So if interest rates rise, so will what you are paid. The sting in the tail is that after a year the rate plummets, possibly to just 0.5 per cent. So get one, but put the anniversary in your diary, and then simply transfer it to a better paying deal then.
Next top is Barclay's Golden ISA, which pays 3.1 per cent AER, though 1 per cent point of which is a bonus lasting 12 months.
● Top Fixed Rate Cash ISAs - up to 3.75 per cent. If you're prepared to lock your cash away, you can earn more with a fixed rate cash ISA, the Halifax offers a two-year fix at 3.5 per cent AER or three years at 3.75 per cent AER. Once your money is in one of these fixed rate ISAs, there are big penalties for taking it out. If interest rates were to rise so your fixed rate no longer looked competitive, it would cost you to move to a better rate elsewhere.
Here's a quick Q&A to deal with the most common ISA-related questions.
● If I take cash out, do I lose the tax benefit?
You can take money out whenever you want without any tax impact. Of course, once outside an ISA, the cash isn't tax-free any more, but you don't have to give back the tax gain you made while it was in there. Once the money has been withdrawn, it can't be returned.
● How many cash ISAs can I have?
As many as you want, but only one for the current tax year's cash ISA. You get a new ISA allowance each tax year, so even if you have opened an ISA before, unless you did it this week, you've got your full 2010/2011 allowance to use.
● Can I still put money in last year's ISA?
No, that year is closed. If you don't use your allocation within the year, you lose it. If you try to do so, it will simply count as opening up this year's allowance with your old provider.
● What if my old ISAs are earning diddly squat?
Transfer them. The best paying cash ISAs that accept transfers are at 2.75 per cent AER. See www.moneysavingexpert.com/isatransfers for all the best deals. Yet beware: don't just take your money out to transfer, as then it's no longer an ISA. Open the new ISA first and ask it to transfer the money across for you. A few ISA providers charge a penalty if you transfer out; do check, as it can diminish the gain.
● Are cash ISAs safe?
You get the same £50,000 per person per financial institution savings protection as any other savings, provided it is in a UK regulated account. The fact that it's in an ISA and you have more than that will not give you extra protection, but provided your combined savings in an institution are under £50k, you will be protected. Always check it is UK regulated.
● Why do you say Santander is a best-buy?
The best-buy is specifically its Flexible Cash ISA but that doesn't mean you are getting a decent rate with its other products (transfer out if not). It is about the product, not provider.