Some taxpayers make more in cash ISAs despite lower rates, study finds

Source: Trustnet

Higher-rate taxpayers have made more money from cash ISAs than regular savings accounts, despite the latter typically offering higher rates, according to data from Moneyfacts.

With chancellor Rachel Reeves mulling changes to the cash ISA, including halving the current allowance to £10,000, the data shows the tax shield provided by the ISA wrapper is more consequential than the average return.

Higher-rate taxpayers in particular will feel the pinch. With savings of £50,000, putting that money into an ISA saves £3,207 in tax. When discounting a higher rate of return from regular savings accounts, the tax wrapper still nets a saver £2,315.

The same is true for less extreme scenarios. With £20,000 (the current ISA allowance), the tax savings stand at £800, while the overall net benefit is around £375.

Moneyfacts also looked at the average cash pot, which stands at £13,500. At this level there is little to choose between the two, with higher-rate taxpayers saving £282 in tax but ending up around £7 worse off due to lower rates.

More than 7 million people are expected to be in this bracket, according to data from HMRC, 500,000 more than in 2024.

Moneyfacts’ Adam French said: “For much of the 2010s, ISAs were underappreciated because of rock bottom rates and the introduction of the Personal Savings Allowance made their tax advantages feel irrelevant. But, with interest rates now back at more sustainable levels, ISAs have regained their purpose.

“When rates were languishing around 1% most savers didn’t earn enough in interest for tax to be an issue but now, due to the combination of frozen tax brackets and greater returns, many do. Higher rate taxpayers in particular stand to lose 40p in every £1 of interest earned beyond their £500 Personal Savings Allowance.”

To calculate this, the firm looked at the best one-year fixed cash ISA versus the best one-year fixed bond available in October of each year over six years from 2020-2025.

Basic-rate taxpayers typically do not need to worry about tax implications, however. The firm found that, at all three different cash pots, savers were better off outside of a cash ISA than within one.

However, while suggestions of cutting the cash ISA allowance may be a consternation to savers, Claire Trott, head of advice at St. James’s Place, said it could be a net positive in the long run.

“The UK population has long been over-saved and under-invested and while a cash buffer is important – promising safe, guaranteed returns – individuals who choose a cash ISA over a stocks and shares ISA could be missing out on hundreds of thousands of pounds over the long term,” she said.

“For individuals saving for long-term goals, the cash ISA approach can be risky. Inflation can quickly and substantially erode the real value of cash savings. Ultimately, those wanting to reap the rewards of their finances over the long term need to be invested in the market.”