Before the personal savings allowance came into being in 2016, the answer to the question “are ISAs worth it?” was a resounding yes. Since the change in 2016, however, The answer has become a little more complicated. In this brief article, we’ll look into the question in more depth – if you want to know the answer to “is an ISA worth it or not?”, please read on.
The Personal Savings Allowance explained
The term “personal savings allowance” (PSA) refers to the tax-free allowance you are entitled to that allows you to make interest on your savings without having to pay any tax on that interest. The size of the allowance is dependent on your income tax bracket and is as follows:
- £1,000 interest tax-free for basic rate taxpayers whose income is taxed 20%
- £500 interest tax-free for higher rate taxpayers whose income is taxed 40%
- No interest-free allowance for additional rate taxpayers whose income is taxed 45%
According to government statistics, the PSA results in 95% of savers not paying any tax on their savings’ interest.
The thing that springs to mind, then, when considering whether an ISA is worth it, is that it could be a more straightforward decision if you fall into the higher income tax brackets.
What PSAs cover
A PSA applies to any interest that you might earn in a number of savings vehicles, including:
- Bank accounts
- Building society savings
- Corporate bonds
- Credit Union accounts
- Government bonds and gilts
- Savings accounts
It also applies to any foreign currencies held in UK savings accounts, like Euros and US dollars.
The interest rate on cash savings today is shockingly low. This means that you have to have £10,000 worth of savings before PSA becomes worthy of any real consideration. So, when asking are ISAs worth it at lower levels of savings, the answer is maybe – the risk involved means you should have at least enough to cover any potential losses. But asking are Stocks and Shares ISAs worth it is a different question entirely and something we will discuss in more detail a little later.
Is an ISA worth it for higher rate taxpayers?
If you are a higher rate taxpayer, is an ISA worth it? Yes, it is when you reach the PSA maximum threshold. As a basic rate taxpayer, for every £100 interest above your PSA in a savings account, you will lose 25%, or £25, to the taxman. As a higher rate taxpayer, you will lose £40.
If you invest in an ISA, however, for each £100 of interest you make over your PSA threshold, you keep the lot. It’s 100% tax-free, so the more you save, the more you save – if you see what we mean. Also, with interest rates as low as they currently are, anyone looking to beat inflation and grow their wealth effectively over the long term should be considering an ISA.
Are ISAs a good idea from other viewpoints?
We’ve limited our discussion to interest so far. But is an ISA a good idea from other perspectives? The answer is yes, it can be for many people
ISAs are flexible
A good ISA gives you a huge amount of flexibility. If you choose the right one, it can enable you to withdraw savings and replace them without affecting your annual ISA allowance, which is £20,000. The key is to ensure that you replace the funds in the same tax year. But before opening any accounts, you should check with your ISA provider as not all ISAs offer this as a feature.
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ISA allowances can be inherited
Why are ISAs good in the long run? Because, since April 2015, couples are allowed to inherit each other’s ISA allowance. The inheriting partner is entitled to an “additional permitted subscription,” otherwise known as an APS allowance. So, as well as having their own ISA allowance, the surviving partner also inherits the value allowance to which their deceased partner was entitled at the time of his or her death.
Why is a Stocks and Shares ISA worth It?
The types of ISAs and saving accounts we’ve talked about so far are cash savings accounts. When you start asking the question, are Stocks and Shares ISAs worth it? – we are looking at a very different picture.
Current Interest Rates
As mentioned previously, the interest on offer in savings accounts is woefully low. This is a result of the Bank of England’s base rate being at an all-time low – a measly 0.1%. It means that many people who are not overly financially savvy are earning interest in the region of 0.01%. However, if you look around, you’ll find that the average annual interest spread is from around 0.5% up to 1.6%.
The lower interest (0.5%) rate is typical of easy access accounts, whereas the higher rate (1.6%) is for a fixed term account, whereby you cannot access your savings until the term is up.
The elephant in the room: inflation
With the upper end of interest on savings being in the region of 1.6%, for this cash to keep pace with its real value, inflation should also be around 1.6%. However, the fact of the matter is that at present, according to the ONS, consumer price index inflation is running at 2.1%.
So in real terms, if your savings are earning 1.6% in a fixed term account, your money is devaluing at 0.5% per annum. And that’s at the high end of savings interest. At the lower end, it is devaluing by as much as 1% per annum. Unfortunately, the bad news doesn’t end there. The Bank of England and other economic experts predict that the rate of inflation could rise to 3% later in the year.
The Guardian suggests that the rate could go even higher, according to a thinktank who forecast that inflation could reach 4%. This means that the value of money left in ordinary savings accounts is going to take a real beating.
Is an ISA a good investment?
If you’re asking yourself, do I still need an ISA? – yes, if you’ve got anything like a substantial amount of money tied up in ordinary savings accounts and Cash ISAs, you really do, unless you’re content to let its spending power in real terms deteriorate badly. If you’re asking the question, are ISAs still best for rates, then yes, if we are talking stocks and share or investment ISAs, they certainly are.
Why choose an ISA?
By now, it will be pretty obvious to the reader that with ordinary savings accounts performing so badly in terms of interest and with inflation due to ramp up, you need a savings vehicle that can outperform inflation. So the question “why are ISAs good?” is answered by the fact that, on average, stocks and shares ISAs often significantly outperform other savings vehicles by some margin.
According to an article published by moneyfacts.co.uk, the average return of stocks and shares ISAs between 1 March 2020 and 2021 was 13.55%, beating the previous year’s average return of 13.3%.
The only thing that you have to consider is your attitude towards risk. Investing in the stock market does pose a risk, and your savings could decrease as well as increase, which is why you should only consider a stocks and shares ISA if you are intent on saving for the long-term.