Savers could avoid paying hundreds, or even thousands, in tax by choosing to put their money in a cash ISA, figures have revealed
With the tax year ending on 5 April, many savers are scrambling to find the best ways to protect their hard-earned cash from the taxman.
Cash ISAs are a simple yet powerful tool that could save you hundreds, if not thousands, in tax over time.
But just how much can it really save you? And with rumours of possible Government changes to ISA rules, is now the best time to open one?
How do cash ISAs work?
Since they were introduced on 6 April 1999 – launched by former Chancellor Gordon Brown to encourage more people to save for the future – cash ISAs have been a go-to option for savers looking to shield their interest from tax.
Unlike standard savings accounts, where interest earned above a certain limit is taxed, cash ISAs ensure every penny of interest stays in your pocket.
Sarah Coles, head of personal finance at Hargreaves Lansdown (HL), said: “The cash ISA season has started early this year, and while endless rumours about possible rule changes have encouraged more enthusiasm for the accounts, it’s not all about the drama.
“There are solid and consistent reasons for picking a cash ISA over a standard savings account, because over the years it can save a serious wedge of tax.”
Here’s how the tax rules currently work:
- Basic rate taxpayers (20 per cent) get a £1,000 personal savings allowance (PSA) – interest earned beyond this is taxed.
- Higher rate taxpayers (40 per cent) only get a £500 PSA – meaning they hit the tax threshold even sooner.
- Additional rate taxpayers (45 per cent) get no allowance at all – they’re taxed on every pound of interest outside an ISA.
But interest rates have risen sharply since 2022, meaning far more people now risk exceeding these limits.
Ms Coles said: “Rising rates since 2022 have changed all that, because with some cash ISAs offering 5 per cent or more, it means a basic rate taxpayer with £20,000 of savings needs to consider tax, and a higher rate taxpayer with £10,000 does too.”
How much could a cash ISA save you in tax?
If you max out your £20,000 cash ISA allowance every year for five years, earning an average 3 per cent interest, by the end of that period, you’d have built up £109,516.
If that money was in a standard savings account with the same 3 per cent interest, here’s how much tax you’d owe:
- Basic rate taxpayer: £981 in tax
- Higher rate taxpayer: £2,806 in tax
- Additional rate taxpayer: £4,282 in tax
That’s money that could stay in your savings instead of going to the taxman – all by choosing to put your money in a cash ISA.
Why more savers are at risk of paying tax
Ms Coles warned that many savers could find themselves paying tax in the future – even if they don’t right now.
She said: “You might look at these kinds of figures and think this isn’t going to be an issue for you, but there are all sorts of reasons why it might. Over time, you will need to build your emergency savings pot.
“When you’re in retirement you should have the cash to cover one to three years’ worth of essential expenses for emergencies, which can easily push you into the realms of tax.
“You might have periods when you’re holding larger sums – such as after downsizing or inheriting, or when you have a looming tax bill, which means you’re holding more savings for a period.”
This is especially concerning because tax thresholds are frozen until 2028. This means that even a small pay rise could push you into a higher tax bracket in which your PSA shrinks or disappears entirely.
She added: “The fact that tax thresholds are frozen until 2028 means there’s a risk a pay rise pushes you over into a higher tax band, where your PSA shrinks or disappears overnight.”
Are cash ISAs still worth it?
One reason some savers hesitate to use a cash ISA is that they have sometimes offered lower interest rates than standard savings accounts.
But that gap has narrowed significantly, and in some cases, cash ISAs are now offering better rates than their taxable counterparts.
At the moment, Chip pays the top rate at 5.25 per cent, although it includes a fixed rate bonus that only lasts 90 days.
Moneybox pays a lower 4.77 per cent and again includes a rate bonus – it lasts for longer at 12 months, although you’re limited to just three penalty-free withdrawals a year.
Ms Coles has reassured savers that the benefits of tax-free savings far outweigh any minor difference in rates.
She explained: “At the moment, you can make more in an easy access cash ISA than the equivalent savings account, and while fixed ISA rates are lower than their savings account equivalents, in many cases they’re only marginally so.
“It means you’re not paying a major price for protecting yourself from tax, and the savings can be impressive.”
Will the Government cut the ISA allowance?
There have been rumours that Rachel Reeves could slash the ISA allowance from £20,000 to just £4,000.
The aim would be to encourage more investment in stocks rather than cash savings.
If this happens, millions of savers could lose the ability to shelter their interest from tax – making this the best time to maximise your allowance before any rule changes come into effect.
Should I open a cash ISA?
For years, cash ISAs fell out of favour, but rising interest rates, frozen tax thresholds, and potential rule changes have made them more important than ever.
If you have savings, a cash ISA is one of the best ways to ensure you never have to pay tax on your interest – now or in the future.
Ms Coles summed it up perfectly, saying: “The savings can be impressive.”
