The ISA Myth

Cash ISA (or NISA) savings accounts are a benefit to the consumer, right? This is because the interest on them is tax free, right? Well, yes, but …

In just opening two new ISA accounts, I’ve bumped into another example of what I’ve known for some years. For the most part, it isn’t the consumer that benefits.

I have transferred two existing Cash ISA accounts from one savings provider, let’s call it A Bank, to another provider, let’s call it B Bank, to benefit from a higher rate. My new ISA rate with B Bank, on a 2-year fixed account, is 1.67% which is considerably better than A Bank’s current rate offering.

But wait, I noticed that I could open a regular 2-year fixed savings account with B Bank and get 2.09%. Think about that for a moment.

A basic rate tax-payer would pay tax at 20% on the interest from 2.09%, i.e. would lose (to the government) 0.418%, making the net gain exactly equivalent to the 2-year fixed rate ISA of 1.67%.

So, who benefits? Not the saver who pockets precisely the same amount of interest. Not the government because they’ve lost their 0.418% in tax.

No, the winner in this tale is the bank, which pockets the difference between what they would have paid had you opened a regular 2-year fixed savings account and the reduced amount that they actually pay you now that you’ve opened a 2-year fixed ISA account instead.

There are a few further wrinkles. Well, there would be, wouldn’t there?

For a higher rate taxpayer, the ISA is still beneficial because they’d be paying more tax [what, 40% these days?] on the interest from a regular savings account. So, the richer buggers are better off to the tune of half their tax on the interest.

For a basic rate taxpayer, though, things could actually be worse. We are now allowed to earn some interest on savings tax free; I think the tax free interest amount is £3000. If all your earned interest does not exceed that amount, a basic rate taxpayer is actually losing money from the ISA because they would not have paid interest on the higher yielding regular savings account. Bother!

The ONLY benefit of an ISA in this last situation is that you are spared the pain of declaring it on a UK tax return form. If you don’t earn the limit in interest, the Cash ISA/NISA is actually detrimental.

Someone is being screwed. Quelle surprise!

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2 comments on “The ISA Myth
  1. Dyslexic says:

    ISAs are a great way of investing in Stocks and Shares. I have no cash ISAs what so ever.

    • JC says:

      Fine if you’re young enough to wait for them to recover after a market crash, IMHO. I’m not. 😉

      I did have some stocks and shares ISAs and suffered through two market crashes when their value dropped. I now have one stocks and shares ISA remaining (it was actually an old PEP) but in retirement the name of the game is protecting the money you’ve built up so I’ve been converting to the safer cash equivalent, which may not quite keep up with inflation in these days of rubbish interest rates, but at least you don’t lose anything. Lose it in later life and you don’t get it back again. [That’s just the view of Mr. Cautious.]

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