Cash ISAs – Slash and Earn?

With interest rates at historically low levels, many cash ISAs are now paying unattractive rates of interest, often less than can be realised from a standard savings account.  As rates have been slashed by providers, do the benefits still stack up?

Cash ISAs give the opportunity to earn interest on cash without the interest being subject to tax.  Over time, individuals can build a substantial tax shelter by investing their full cash ISA allowance each year.  The allowance in 2009/2010 is £3600, with the curious addition of an extra £1500 allowance for anyone over 50, available from October 6th 2009.  Going forward, the allowance will rise to £5100 for all in 2010.

Until recently, a common gripe of cash ISA investors was that they could get an attractive rate, but only on their allowance for the current year.  Old cash ISA accounts would see their initial high rates fall away, and new accounts would not allow the transfer in of existing cash ISA funds.

The current situation is that cash ISA interest rates are historically low, but providers are again allowing transfers of existing ISAs into new accounts.

For higher-rate tax payers, they remain attractive – an interest rate of 2.5% on an ISA would beat a taxable rate of 4.16%.  For basic rate tax payers, a 2.5% ISA rate beats a  taxable rate of 3.2%.  And don’t forget, you may only be a promotion or two from becoming a higher rate tax payer, so it could make sense for you to squirrel that money away now, if you can afford to.

The best rates tend to go to those who have either the most money in their ISA or who are prepared to tie up their money for the longest amount of time, but good deals do arise – it is up to the savvy investor to keep abreast of new offers, determine what is best for them and move quickly to avoid disappointment.

Check with your bank or building society, or for the bigger picture, investigate comparison websites or the ‘best buy’ pages of the financial press.

Remember though, that what is a good deal at the time may not be so good later on.  Keep an eye on your rates if they are variable, and keep a weather-eye on the overall market.  Competition for investor’s cash breaks out between firms in March and April as they hustle for people using up the current tax year’s ISA allowance and investing quickly for the following tax year’s ISA allowance.  This is often a good time to snap up deals.

If you do decide to switch your cash ISA to another provider, remember to take careful note of the process.  Usually, your new provider will request a form completed with your old cash ISA details, and they will arrange the transfer for you.  If you take the cash out in order to pay it to another provider, you will lose the tax-free status of your cash.  Check with your new and current provider, and make sure you know the full rules by checking the HM Revenue & Customs website.

Pros – Tax-free shelter, ability to transfer funds between ISA providers (subject to individual terms and conditions), expected increase in allowance in future years.

Cons – Current low rates of interest, more paperwork than a standard savings account, convoluted process for transferring between providers, limit on investment.

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