Savings account Guides

Cash ISAs

Updated: 15 June, 2011

By Hazel Cottrell - hazel.cottrell@consumerchoices.co.uk

If you have savings but are not using a cash ISA, then you're almost certainly paying the taxman more than necessary.

A cash ISA is one of the simplest products on the financial market; a savings account that allows you to put money aside without having to pay any tax on the interest you receive.

For almost everyone in the UK who pays tax, a cash ISA should be the first destination for savings, so in this guide we look at the best way to use your cash ISA allowance.

Once you've digested this guide, make sure you compare ISA accounts to find the best deal for your needs.

• Cash ISAs - the basics
• Choosing a cash ISA
• Cash ISAs vs savings accounts
• Switching cash ISAs
• Top tips to get the most from your cash ISA

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Cash ISAs - the basics

ISAs were introduced by the government in April 1999 to encourage saving, and the tax benefits are certainly worth making the most of.

• Cash ISA Allowance - For the current tax year 2011/12 which ends on 5 April 2012, you can invest up to £5,340 in a cash ISA. Any interest on your cash ISA earns is completely tax free.
• Opening an ISA - To open a cash ISA you must be aged over 16 and a UK resident (or a Crown employee serving overseas or married to such an employee). When you open an ISA, you will normally need to show some form of identification, such as your passport or driving licence to prove your identity and a utilities bill or bank statement to verify your address.
• Where to get an ISA - Cash ISAs are offered by banks, building societies and National Savings & Investments. To ensure you're getting the best rate, it’s crucial to compare ISA deals and read the terms and conditions of the account. You can only have a Cash ISA with one provider in any tax year, which means you can’t split your allowance between accounts. However, you can have Cash ISAs from different providers in different tax years.
• Withdrawals - Many easy access cash ISAs will allow you to withdraw you money at any time without penalties. However, you should think twice before making withdrawals as any money withdrawn from a cash ISA cannot be returned to top it back up. The annual allowance refers to the amount you can deposit during the year - not the balance of the account.

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Choosing a cash ISA

Although a cash ISA is one of the simplest products on the financial market, there are a few things you need to look out for:

• Bonus rates - As with standard savings account providers, many ISAs offer bonus rates to attract customers, but these can be short term and can drop dramatically after the first year. It’s a good idea to make the most of these high rates, but make sure you switch again as soon as the rate becomes uncompetitive.
• Paying money in - Most easy access cash ISAs allow you to pay money in at any time and some will allow you to start with as little as £1. However, some ISAs do have higher minimum balance requirements and many fixed rate cash ISAs only accept a single lump sum deposit. If you want to drip feed your money in, make sure you choose an account that allows this.
• Withdrawals - Some ISA providers may put annual limits on withdrawals or apply withdrawal penalties such as reduced interest. This isn’t a problem if you’re sure you won’t need access to your cash (you should try to avoid withdrawals as withdrawn cash cannot be reinvested above your annual limit) but if you think you might need to get your hands on it look out for these clauses as they could have a negative effect on the interest you receive.
• Transfers - As we'll cover in greater detail later, switching ISAs allows you to get the best interest rates on your cash. However, not all ISAs allow transfers, so this is something to bear in mind when comparing deals. A few providers also apply transfer penalties, which will penalise you if you try to switch your cash to another provider.

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Cash ISAs vs. savings accounts

Top cash ISAs will almost always beat the best buy savings account, because interest earned in an ISA is not subject to tax.

Interest earned from a standard savings account is immediately subject to a tax of 20% if you are a basic rate tax payer or 40% if you are a higher rate tax payer.

However, all interest from an ISA comes directly to you completely tax-free and you are not required to declare any ISAs on your annual income tax return.

This means that even if the interest rate on an ISA is slightly lower than that on a savings account, it will often allow you to earn more annual interest. It’s important to shop around for the best rate, but generally a cash ISA should be the first place to stow your savings.

For a full explanation and examples of the effect of tax, read our guide ISAs vs savings accounts.

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Switching cash ISAs

If you want to get the most from your savings then it’s likely you will have to switch ISAs at some point.

Indeed, many cash ISAs come with tempting bonus rates that end after a year, so it makes sense to make the most of them then switch when the special offer ends.

Keep a close eye on the interest rate you're receiving and if there are better deals out there, switch your account.

Switching ISAs should be fairly straightforward but to make sure you don’t lose your tax free entitlement, it’s essential that you follow the golden rule: Never withdraw money from your cash ISA.

If you withdraw money from your existing ISA, with the intention of transferring it to another ISA, that cash will lose its tax free status.

Instead, to switch ISAs whilst keeping your cash in its tax free wrapper, you will need to arrange a transfer. You should ask the financial organisation providing your new ISA to set this up for you. Once you have filled out a transfer form they will arrange for the money to be moved, keeping its tax free status intact.

For more information read our guide to switching cash ISAs.

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Top tips to get the most from your cash ISA

For maximum benefits, ensure you do the following:

• Make your cash ISA the first place you put your savings
• To make the most of your cash breaks; use as much of your annual allowance as possible
• Invest your cash in your ISA early in the year so you can earn the maximum interest on your savings.
• Try not to withdraw money from your ISA if you can avoid it – if you’ve used up your allowance, the withdrawn money cannot be re-invested in that tax year
• Keep an eye on the interest rate you're getting and regularly check for better deals
• When switching ISAs, make sure you arrange a transfer, rather than closing one account and opening a new one.

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Download our complete guide to ISAs