Higher Rates of Interest Paid on Standard Fixed Rate Savings Accounts than Cash ISAs

Written by Karen Bryan

£20 Bank of England notes1It appears that savers who are standard rate income tax payers with earnings, benefits and/or pension income of more than annual personal allowance (currently £10.600), could do better by putting their money into a standard fixed rate savings account (which matures no earlier than 6 April 2016), as opposed to a fixed rate Cash ISA.

This is due to the introduction of the first £1,000 of savings interest being tax-free for basic rate income tax payers from 6 April 2016, and the fact that standard fixed rate savings accounts are currently paying a higher rate of interest than fixed rate Cash ISAs.

What I’d like to see is savers being able to use a tax-free Cash ISA wrapper on any available savings accounts. This would mean that the same rate of interest would be paid regardless of the tax status of interest earned.

One Year Fixed Rate Accounts: Standard versus Cash ISA

If you have at least £1,000, you can earn an interest rate of  2.06% on the Chartered Savings Bank One Year Fixed Rate Bond. The highest rate I could find for a Two Year Fixed Rate Cash ISA was 1.75% from several providers including  the Molmesdale Building Society, Shawbrook Bank and Julian Hodge Bank.

Two Year Fixed Rate Accounts: Standard versus Cash ISA

If  have at least £1,000, you can earn an interest rate of 2.38% on the Secure Trust Bank Two Year Fixed Rate Bond. The highest rate of interest I could find for a Two Year Fixed Rate Cash ISA was 2% with several providers including Virgin, Halifax or the Skipton Building Society.

Three Year Fixed Rate Accounts: Standard versus Cash ISA

If you have at least £1,000, you can earn a rate of 2.65% on the Chartered Savings Bank Three Year Fixed Rate Bond. The highest rate of interest for a Three Year Fixed Rate Cash ISA is 2.25% from Virgin. Update 13 August 2014 – Leeds Building Society is offering 2.3% on their Three Year Fixed Rate Cash ISA, which allows penalty free access of up to 25% of the original investment.

How Much Can You Have in Savings to Stay Within the £1,000 Tax-Free Limit?

To take full advantage of the £1,000 tax-free interest you could put around £35,000 into the Chartered Savings Bank Three Year Fixed Rate Bond paying 2.65%, which would keep the interest paid below £1,000 by the third year, allowing for compounding.

However, if your total income from work, benefits and/or pensions is less than your annual personal allowance,  currently £10.600, you can earn up to an additional £5,000 in interest per year free of income tax. This is in addition to the new £1,000 tax-free limit.

Should I Go for a Standard Rate or Cash ISA Fixed Rate Account?

Let’s say that you put this year’s full ISA allowance of £15,240 into the Chartered Savings Bank Three Year Fixed Rate Bond paying 2.65%; you’d earn interest of £403.86 at the end of the first year, well below the £1,000 limit. If you put that £15,240 into the highest paying Virgin Three Year Fixed Rate Cash ISA paying 2.25%, you’d earn interest of £342.90, around £60 less than in the standard fixed rate account.

At the currently available rates of interest, if  you are a basic rate tax payer with a few thousand pounds in savings on which you’d like to guarantee the rate of interest, it looks like you should go for the savings account that pays the highest rate of interest, currently a standard saving account.

However, if you are a basic rate tax payer with an income from work, benefits and/or pensions above the annual personal allowance, who already has total savings of more than around £30,000 and/or plan to build up a large cash nest egg for retirement, you are probably better put the majority of your savings into Cash ISAs, to preserve their tax-free status, even if the gross rate is slightly lower than a standard account.

Bear in mind that if interest rates paid on savings do eventually begin to increase, the suggested savings total of £30,000 to trigger using Cash ISAs will drop. There’s also the possibility of changes to the £1,000 tax-free interest limit and/or the Cash ISA regime.

Warning and Disclosure – This article is based on my personal research and understanding of the HMRC tax rules on income and savings and the rates of interest available on 8 August 2015. Please ensure that you do your own research into income tax regulations and calculations of the available interest rates.