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ISAs vs. Savings
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Interest on ISAs vs. Standard Savings Accounts
Compare Savings Accounts >>.
When comparing the difference between an ISA and a normal savings account, an ISA offers you one crucial benefit: You don’t pay any tax on the interest that you earn.
With a standard savings account, any interest given will immediately be subject to tax at the basic taxpayer rate of 20% (or 40% if you’re a high earner).
You don’t need to declare an ISA on your annual income tax return, so all the interest earned is yours to keep.
ISA – Individual Savings Accounts
Individual Savings Accounts, more commonly referred to as ISAs, were introduced on 6th April 1999. Replacing the defunct Personal Equity Plans, the Government introduced them as a tax efficient incentive to encourage savings.
There are two types of ISA, mini and maxi. The total amount you can save each tax year (April to April) cannot exceed £7,000 in either.
An ISA comprises an investment in cash of up to £3,000, and other investments (such as stocks and shares) up to a value of £4,000. Mini ISA holders can take two each tax year, but one must consist of a cash investment and the other stocks and shares. Maxi ISA holders are limited to one a year, and it must solely be made up of stocks and shares.
In the March 2007 Budget , the then Chancellor, Gordon Brown, announced an increase in the allowances for the 2008-9 tax year. From 6th April 2008, the cash limit of an ISA will increase to £3,600 and the stocks and shares proportion is set to rise to £7,200. The distinction between a mini and maxi ISA will be abolished to simplify the process.
Savings Accounts
Savings accounts offer you a slightly better interest rate than an ISA, but any interest you accumulate will be subject to tax. The amount of tax you pay will be determined by your current rate of income tax. You'll only be subjected to the higher rate if your annual earnings are over £34,600. Standard rates are set out below:
| Rate |
Tax on Interest |
Tax on Income |
Band (above any personal allowance) |
| Starting Rate |
10% |
10% |
£0 to £2,230 |
| Basic Rate |
20% |
22% |
£2,231 to £34,600 |
| Higher Rate |
40% |
40% |
over £34,600 |
Case Study
Here's a typical ISA vs savings account scenario, think about how this might apply to you:
'Margaret has an annual salary of £20,000 and pays the basic rate of income tax on her earnings. She has £1,000 in savings to invest and is looking to compare the best accounts on offer at the Alliance & Leicester. Would it be more profitable to park her money in a savings account or an ISA?'
Alliance and Leicester E-savings account
If Margaret opted to invest her £1,000 into this savings account (AER 6.5%), she will have gained £52 interest in 12 months after tax deductions.
Alliance and Leicester Direct ISA Issue 3
The Alliance & Leicester’s Direct ISA issue 3 offers a lesser interest rate (AER 5.9%), but she will earn £59 interest over the same period due to the tax breaks involved with ISAs.
| Account |
Interest Rate |
Annual Interest Rate |
| e Saver |
6.5% |
£52.00 |
| Direct ISA issue 3 |
5.9% |
£59.00 |
Round up
Investing the first £3000 of your savings each tax year into an ISA will maximise your returns. Don't rule out a savings account though if you have more money to save than an ISA can handle, or if you're especially wary of investing in shares. Share values can of course go down aswell as up. Shop around for the best rate of interest on a savings account as they do vary, and think about taking out a savings account in conjunction with an ISA if you have large amounts of money to save.
Click here to Compare Savings Accounts.
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