Out in the cold
The outlook continues to look bleak for Cash ISA savers, who are at risk of wasting the potential benefits of this year’s ISA allowance.
ISAs have been an unquestionable success in helping foster the UK’s savings habit. Over £518 billion was held in ISAs at the end of the last tax year¹, and April’s increase in the annual allowance to £20,000 will be another welcome step towards encouraging individuals to make provision for their financial future.
There are a few weeks left for savers and investors to use this year’s ISA allowance, and the run-up to 5 April is traditionally the period when banks and building societies launch new accounts to tempt savers. But this year it’s different, as institutions battle to avoid topping best-buy tables in an attempt to overcome the problem of attracting too much money. Savings accounts cost the banks money. While they need some money from savers, they want to pay as little for it as possible.
At the beginning of February, National Savings and Investments (NS&I) made headlines when it announced cuts to four of its key accounts, including its Cash ISA, which had been the market leader since December. NS&I’s motivation was slightly different – its function is to reduce the cost to the government of raising money, and it reduces rates once the Treasury’s target has been exceeded – but the impact on savers is just the same.
The rates of top-paying, variable rate Cash ISAs have fallen by as much as 30% since September.2 The challenge for savers has been made even harder by the recent surge in inflation. The latest figures from Moneyfacts show that, across the entire cash savings market, only 23 out of 697 accounts offer rates that match or beat inflation – and they are all fixed-rate bonds. There are no Cash ISAs that meet this basic requirement.²
Source: Bank of England, February 2017
With inflation expected to hit 2.7% in 20173, and economists forecasting that interest rates are likely to be going nowhere fast, there appears to be little light at the end of the tunnel for cash savers. Will this year deliver a change to the long-term trend that has seen 80% of ISA subscriptions deposited in cash?³
The introduction of the Personal Savings Allowance last April also seems to have exerted downward pressure on Cash ISA rates. Cash ISA rates typically lag behind what can be earned on a taxable savings account and have fallen more sharply since the August base rate cut, reflecting less appetite among providers to compete in this market.
Research conducted by Mintel last year revealed that over half of people don’t understand the impact of the Personal Savings Allowance on their cash holdings.⁴ The allowance applies to standard current and savings accounts and enables a basic-rate taxpayer to earn tax-free interest of up to £1,000 each year. For higher-rate taxpayers, the tax-free limit is £500.
According to Moneyfacts, the average instant access savings rate is currently 0.37%.⁵ At that level, a basic-rate taxpayer could deposit over £270,000 in a regular savings account and receive all their interest tax-free through their Personal Savings Allowance. For higher-rate taxpayers, the figure is just over £135,000. It is little wonder that savers and providers alike are questioning the role of Cash ISAs when cash sums of that amount can earn tax-free interest.
Of course, as and when interest rates rise, the amount of money on which tax-free interest can be earned will reduce, whereas funds held in a Cash ISA will retain their tax benefits. But meaningful increases in cash rates appear to be some years away.
In the meantime, those yet to use their allowance in this tax year, or those with accumulated Cash ISA savings, may wish to consider a Stocks & Shares ISA. These higher-risk vehicles may improve prospects for better returns by making the most of the tax benefits available, and because they offer the scope for attractive levels of income and capital growth over the long term.
The value of an ISA with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than you invested. An investment in a Stocks and Shares ISA will not provide the same security of capital associated with a Cash ISA.
The favourable tax treatment of ISAs may not be maintained in the future and is subject to changes in legislation.
¹’ ³ HMRC, September 2016
²’ ⁵ Moneyfacts, February 2017
⁴ Mintel Deposits and Savings Accounts - UK, June 2016