Make The Most Of Your Cash ISA

Cash ISAs have been a huge success since they were introduced in 1999. In the last year 11.5m people, roughly one in four of the adult population in the UK, took one out. On average, each person put in £2,200, meaning we collectively saved a massive £25bn!

What are they?

A cash ISA is simply a tax-free savings account. While your money remains inside the ISA, any interest you earn is tax free. You can open a new ISA for each tax year, which runs from April 6 to April 5. There’s a limit on the amount you can put in each year, as the taxman doesn’t want to lose out too much. For the current year it’s £3,600, a 20% increase on the £3,000 limit that has been in place since cash ISAs were first introduced.

It’s important to note that the annual limit is cumulative. So, for example, if you put in £3,600 in May and then took out £1,500 in June you wouldn’t be able to put any of this money back into your ISA (not until the following April 6 anyway when it would go into a cash ISA for next year).

You can only open one cash ISA a year so you can’t put £2,000 into one account and £1,600 into another. There is nothing to stop you holding cash ISAs from different years with different companies, but you can also transfer a cash ISA from one company to another if you want to keep all your money in the account with the best rate – more on this later.

Anyone aged 16 and over can have an ISA, whether they pay tax or not. Even for non-taxpayers ISAs can make sense as they could become taxpayers in future and then they’ll earn tax-free interest from money they put in previously. In fact, someone who has put the maximum amount allowed into cash ISAs each year and has reinvested the interest they received would now have a total of around £40,000 stashed away safe from the taxman. Higher-rate taxpayers who’ve done this are now saving around £1,000 a year in tax on the interest they earn.

What rates can you get?

Most cash ISAs offer a variable rate of interest, typically paying slightly less than you can get for the highest paying easy access savings accounts. You can also get cash ISAs that pay a fixed rate of interest but these often have quite heavy penalties in terms of lost interest if you withdraw your money early. Other cash ISAs require a notice period of one to three months before you can get hold of your cash. Whenever you look at a cash ISA, make sure you understand how quickly you can access your money when you need to and what penalties, if any, could apply.

You can also get some unusual cash ISAs that offer some exposure to the stock market. These products usually don’t offer very good value and you’ll normally be better off investing directly in shares or in a mixture of cash and shares.

Like ordinary savings accounts you can also get accounts that pay an initial bonus rate of interest for, say, the first six months. These are rarely worth getting though as you’ll normally be better off with an account that pays a consistently high rate. Unfortunately, like all savings accounts, the rates offered on cash ISAs often drift back over time. So a cash ISA that was a top payer when you took it out might be far less competitive two or three years later. This is when you might want to consider transferring your cash ISA elsewhere.

Transferring your cash ISA

The key thing to remember when moving a cash ISA is not to close your original account. If you do this your money will lose its tax-free status. Instead you want to transfer your ISA. Your new provider should handle most of the legwork for you if you give them the necessary details. But the process can take a little time. Often accounts that pay the highest rates are very popular and administration backlogs occur. You shouldn’t lose any interest as a result of this but check with your ISA provider if you think this may have happened. Be aware that some new cash ISAs don’t allow any transfers in from accounts opened from previous years.

Many people save into a cash ISA each month using a direct debit. If you do this, the first direct debit payment on or after April 6 of each year will automatically open a new cash ISA account for that year. So make sure you cancel your monthly payment in time if you decide to open a new cash ISA elsewhere.

What happened to TESSAs?

You might remember a previous form of tax-free savings account called a TESSA. These were available from 1991 to 1999. Each account lasted for five years and you could put in a total of £9,000 over this time. Maturing TESSAs could be put into TESSA-only ISAs to preserve their tax-free benefits but, as of 6 April 2008, all money previously held in TESSA-only ISAs is now classified as a cash ISA. This makes things a lot simpler as you can now transfer money from both old TESSAs and cash ISAs from previous years into the highest-paying accounts.

Switching to a share ISA

Several new rules were introduced for ISAs in April 2008. For example, old confusing distinctions such as mini ISAs and maxi ISAs were done away with. Now we simply have cash ISAs and shares ISAs. We look at share ISAs in a separate article but one aspect is worth mentioning here. You can now transfer money held within a cash ISA to a share ISA. For some reason, you can’t do the opposite, transferring money held in a share ISA back into a cash ISA.

Why might you want to make the switch from cash to shares? Well, if you have managed to build up a sufficient amount in cash, you might want to attempt to get the higher long-term rate of return that investing in shares can offer.