Every little helps: maximising your savings with ISAs
In the words of Tesco, every little helps. And that’s a rule to live by when it comes to maximising your savings. Whether it’s switching to an account that pays more interest, rounding up your spare change or — the focus of this blog — minimising the tax you pay on your savings, small efficiencies can make a big difference.
When it comes to minimising the tax you pay on your savings, whether you’re just starting out on your savings journey or you’re a seasoned saver, understanding ISAs (Individual Savings Accounts) is key.
What are ISAs?
ISAs offer an opportunity for UK taxpayers to grow their savings tax-free. Each year (starting 5th April), you’re given an allowance, currently £20,000, to save into ISAs, and anything earned on this money — whether interest or investment returns — is free from both income and capital gains tax. The attractiveness of this varies depending on your individual circumstances, which I’ll explain later.
Not having to pay tax on your savings might not sound like much, but compound interest means this small change could become meaningful over the long term.
Let’s take a look at some numbers, shall we?
Imagine you’re a higher rate taxpayer and you put your full £20,000 allowance each year into an ISA offering 5.08% AER (which, at the time of writing, is the maximum you can earn on Zopa’s easy access cash ISAs† — this includes a 1-year fixed bonus rate of 0.5% AER, which starts from the date you open a Smart ISA. In 26 years‘ time, you’d have over £1 million stashed away — around £200,000 of which is money that would have otherwise gone to the tax man.
If this got your heart racing, keep your eyes peeled as I’ll be sharing a simple 4-step process on becoming an ISA millionaire in a later blog!
Are the tax benefits worth it?
Before you’re seduced by the tax benefits on offer, it’s important you understand whether or not they apply to you.
Outside of ISAs, UK taxpayers can earn a certain amount of interest on their savings each year before paying tax. This is called a Personal Savings Allowance (PSA). The current PSA for basic rate taxpayers is £1,000, falling to £500 for higher rate taxpayers and £0 for additional rate taxpayers.
Non-ISA savings accounts often offer higher rates, so it could pay to make use of your annual PSA before saving into an ISA if you can get a better rate elsewhere. For context, based on the current top-paying accounts, higher rate taxpayers could save approximately £9,500 into a non-ISA account before exceeding their PSA. This rises to around £19,000 for basic rate taxpayers.
When it comes to reaping the tax rewards of ISAs, it’s important to know that your money must remain in its ISA wrapper to retain its tax-free status. So, if you’re looking to move your ISA savings to another provider — for instance, one that’s offering a higher interest rate — it’s important you transfer it, rather than withdrawing your money and resaving it elsewhere. This way, your money will keep its ISA wrapper, and you won’t eat into your current year’s allowance. Some providers make the ISA transfer process smoother than others — like Zopa†, who let you request a cash ISA transfer of as little as £500 in just a few taps in their app.
Are all ISAs the same?
No, you’ll be pleased to hear there are several types of ISAs to choose from, each suited to a different savings goal.
Cash ISA: A risk-free way of saving, where you earn tax-free interest on your money. Some offer variable interest rates — meaning the rate can go up or down — while others let you lock your money away for a set amount of time in exchange for a fixed rate.
Stocks and shares ISA: Invest in stocks, bonds and other assets, without being taxed on the gains.
Innovative finance ISA: Invest in peer-to-peer lending or crowdfunding platforms.
Lifetime ISA: Designed for first-time homebuyers and retirement savings. The government provides a 25% bonus on contributions. The maximum you can pay in each year is £4,000, which means there’s an annual bonus of £1,000 up for grabs. Lifetime ISAs must be opened before you’re 40, and you can continue contributing to it until you reach 50. Although you won’t be able to withdraw your savings until you hit 60 (unless you’re doing so to buy your first home) — withdrawing before then will trigger a penalty fee. The rules surrounding Lifetime ISAs can get a bit complicated, but I’ll go into more detail in my next blog.
Junior ISA: For parents or guardians to save up to £9,000 per year for their child’s future. Available as cash or stocks and shares.
You can choose to pay your annual ISA allowance into a single ISA or split it across different types. In the past, you could only pay into one of each type of ISA per tax year. But as of 6th April 2024, you’re able to pay into multiple of each type (except Lifetime ISAs).
When it comes to choosing the right ISA for you, a key consideration is how easily you want to be able to access your savings. Unlike fixed rate bonds, fixed rate cash ISAs are generally accessible — although you may have to pay a hefty interest charge to access your money before the fixed term ends. That said, if you don’t think you’ll need to access your savings but would like the reassurance of knowing you can get to them if needed, a fixed rate cash ISA could be a sensible option.
On the other hand, if you’d like complete access to your savings, an easy access cash ISA could be a better option. Plus, most are currently offering better rates than fixed term ones due to the expectation that interest rates will fall over the coming years. If you choose to open an easy access cash ISA, it’s worth looking for a flexible one — these allow you to move money in and out of your ISA without affecting your annual allowance. Zopa offer a great flexible easy access cash ISA† and, unlike most competitors, they enable you to spread your savings across multiple easy access and fixed term ISA ‘pots’ within a single cash ISA, so you don’t need to choose between the two.
Another factor that determines the accessibility of your savings is how you’re able to physically get your hands on it. Although many ordinary savings accounts can be opened and managed from an app, very few ISAs can. There are also several ISAs that can be opened by one channel but not managed by it. For example, perhaps you can open a particular ISA on the internet but only manage it over the phone. If you’re keen to manage everything to do with your ISA in the click of a few buttons, an app-only ISA, like Zopa’s†, could be the solution for you.
If you’re still not sure which type of ISA is right for you, don’t worry, as I’ll be covering the differences in more detail in my next blog.
Is now a good time to open an ISA?
As I mentioned earlier, your annual allowance renews each tax year (on 5th April). So, there are two reasons why opening sooner rather than later makes sense:
To make the most of your allowance: If you don’t use your £20,000 allowance, you’ll lose it. So, if you have any savings tucked aside that could benefit from growing tax-free, consider popping them in an ISA.
To make the most of compound interest: Interest is usually paid on a daily or monthly basis, so the sooner you fund your ISA, the sooner you’ll start to benefit from the tax-free growth on offer.
A third, bonus reason, why opening an ISA now is a good idea is to benefit from the bonus interest rate currently being offered by Zopa†. At the moment, you can earn an extra 0.5% AER on their easy access cash ISA, giving you a total of 5.08% AER.
So, if you’re keen to maximise your savings potential, ISAs are a good place to start. You can open a flexible, easy access cash ISA with Zopa from the app in just a few taps. And you can rest assured knowing your money will be in safe hands, as they’re FSCS protected and have over £ billion in savings. What’s more, Zopa’s been consistently competitive on interest rates since launch, winning several awards, including Moneynet’s Best Fixed Rate Cash ISA Provider 2024.
Before you go, I thought it was only right to nudge you to check up on any old ISAs you may have lying around. Interest rates have soared over the past few years so there’s a good chance you could be getting more bang for your buck elsewhere. In fact, the higher rates on offer may even offset any interest penalties you could be charged to transfer your fixed term ISA savings.
This is the first in a series of ISA blogs, so keep an eye out for my next one where I’ll be going into detail on the different types of ISAs available.
Disclaimer:
The views expressed are those of the author. This blog is intended for information only and doesn’t constitute financial advice. You should always do your own research to ensure anything you apply for is suitable for your specific circumstances.
Tax treatment depends on individual circumstances and may change. Interest rates are correct at the type of writing by may go up or down in the future. If you choose to invest, you may get back less than you put in.
†Smart Saver account and minimum £1 required. Access ISA pots 5.08% AER (4.96% gross) variable, payable monthly. This includes a 1-year fixed bonus rate of 0.5% AER/gross, which starts from the date you open a Smart ISA.
AER stands for 'annual equivalent rate'. We pay you interest on a monthly basis, but AER shows you the rate you’d get if this monthly interest was compounded and paid once a year instead. We provide an AER to make it easier for you to compare our rates with other providers.
Gross is the rate of interest we apply to your money, before any tax is taken off.
This blog was updated on 17th May 2024.
