A cash ISA (individual savings account) is a type of savings account with special tax advantages: you do not have to pay income tax on the interest you earn.There are limits to how much money you can put in a cash ISA in any tax year (which runs from April 6 to the following April 5).In the 2010-11 tax year, the limit is £5,100 per person, and this is due to be raised in line with inflation every year from next year onwards. If you have put money into a stocks and shares ISA, it may affect how much you can put in a cash ISA. In 2010-11, if you put more than £5,100 in a stocks and shares ISA, your cash ISA allowance will be reduced – your total ISA savings can not exceed £10,200 in this tax year.So if you put £8,000 in a stocks and shares ISA in 2010-11, for example, you would only be able to put a maximum of £2,200 in a cash ISA.
As well as investing this year’s cash ISA allowance you can also transfer money invested in previous tax years without it losing its tax-free status. However, not all cash ISAs accept transfers in so bear this in mind when comparing products. You might also find that you can only make a transfer if you invest some of this year’s allowance as well. In other words you can’t use all of your 2010-2011 allowance for a stocks and shares ISA and open a new cash ISA purely to transfer an existing investment into. Some deals have very low minimum deposits though, so you won’t necessarily need to invest the full £5,100 cash ISA allowance in order to make a transfer.
As with standard savings accounts, there is a wide range cash ISAs including easy access accounts, fixed rate bonds and regular savers.
You have to be 16 or older to open a cash ISA.
What are the advantages?
The tax savings on ISAs can be significant, especially if you have built up a large holding over a number of years.
For example, if a cash ISA was paying 3% annual interest, a basic-rate (20%) taxpayer would have to find a non-ISA account paying 3.75% to get the same return after tax.
A higher-rate (40%) taxpayer would need a non-ISA account paying 5% – and someone in the new 50% tax band would only get an equivalent return from an account with 6% interest.
Research from moneysupermarket.com found that a higher-rate taxpayer who had used their full cash ISA allowance every year since ISAs were introduced in 1999, and moved their money to the highest paying account each year, would be nearly £6,000 better off than if they’d kept their money in a standard savings account. Someone in the basic tax band would be £3,000 better off.
You can move money into a new cash ISA without losing the tax-break if the interest rate on your existing account becomes uncompetitive.
What are the disadvantages?
The maximum you can pay in to a cash ISA is capped and you cannot exceed your annual allowance.
Not all accounts accept transfers in and often those offering the highest interest rates are only available for this year’s allowance. You therefore need to bear this in mind when comparing products.
Extra care should be taken when moving money from one ISA provider to another. If you withdraw money from an ISA, it loses its tax-free status.
To switch accounts, you need to ask your new provider to make a transfer, which means you keep your tax advantages.
You can transfer money from a cash ISA into a stocks and shares ISA but not the other way round ie. money in stocks and shares can’t be moved into cash.
Who do they suit?
If you pay income tax, a cash ISA is probably the best home for the first £5,100 of savings you have. But make sure you compare accounts to ensure you get the best rate possible.
While easy access cash ISAs will let you get at your money whenever you want, try not to dip into your ISA savings unless it’s absolutely necessary. If you take money out of an ISA it can’t be put back in and you lose the tax-free status on it. You should therefore use other non-ISA savings first.
© Copyright Burnt Orange Accounting
By Kerry Davies
