‘Tax axed on savings for 95% of the population’. There’s a headline, but what lies behind it and where do you stand with your cash ISAs now?
These, and related questions are being asked by savers and financial journalists alike, but some questions have remained unasked, so let’s take a look at the fuller picture.
From April 2016, savers will be able to earn £1,000 p.a. tax free on their cash deposits. Higher rate tax payers will be able to earn half of that. Based on current interest rates and assuming you are a basic rate tax payer, you would need around £74,000 on deposit to earn that level of interest. Admittedly, a higher rate tax payer would need to have half that amount of capital, but a little bit of pension planning (using some of that capital?) could soon see you benefit from the full £1,000 allowance if your earnings are slightly above the higher rate tax threshold.
So, where does this leave the cash ISA?
Cash ISAs have long term protection against savings tax. As for the new rule announced in the Budget, this could eventually get eroded or taken away, like MIRAS on mortgage interest payments. Right now, with such low rates, the new tax break looks attractive, but as interest rates rise, the amount of savings required will gradually fall and the tax benefits will reduce. In other words, it still makes sense to use your ISA allowance first.
There are potential inheritance tax benefits. ISAs have a long term tax free status built in and most importantly, there is the opportunity to switch into stocks and shares ISAs at a later date and this leads on to the next point: Fidelity Personal Investing stated that: Had it been possible to do so, an investment of £15,000 in an ISA into the FTSE All Share Index in February 2005, would have grown to £31,889 by the end of February 2015. This time frame includes the considerable fall in equity markets in October 2008. Had the same sum been invested in a cash ISA using the average deposit rate, the ISA would be worth £16,321.36. At that rate, it would not have even kept up with inflation.
The story does not end here. There are a few cash ISA providers with ‘headline grabbing interest rates’ – nothing too exciting though as they are still around the 1.35% mark, but there is a sting in the tail. These instant access accounts are starting to reduce their accessibility and in some cases, withdrawals are limited to a small number each year – so not quite as accessible as you think.
This raises a different question. Should the money be held on deposit (in whatever form of tax protected savings account), or should it be invested in stocks and shares? Rates and access are important, but so is the intended investment term and your acceptance that there is a degree of risk in investing in the stock markets but it is definitely a question worth considering especially if you want to beat inflation or generate additional income.
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