Recent research reveals savers have been ditching cash ISAs left, right and centre. In contrast, stocks and shares ISAs have been rising in popularity.
However, just days ahead of the ISA deadline, cash ISA rates are starting to nudge upwards. So, should you rethink your tax-free saving plans? Let’s take a look.
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Are cash ISAs becoming less popular?
According to AJ Bell, UK savers withdrew £7 billion from cash ISAs during the last six months of 2021. This was the biggest collective sum withdrawn from ISAs since they were introduced back in 1999.
Laura Suter, head of personal finance at AJ Bell, explains why this is a significant stat: “The outflows of £7 billion are 46% higher than the outflows seen in the final six months of 2020, which stood at £4.8 billion and were the highest outflows on record at the time.
“For the past six years, the final six months of the year have seen outflows from ISAs, but none as large as we saw in 2021.”
It’s likely that many cash ISA deserters are moving their wealth to stocks and shares ISAs to seek higher returns. However, this is unlikely to be the case for all former cash ISA holders.
So, let’s take a look at two reasons why cash ISAs have lost their way in recent times.
1. Low interest rates
Cash ISA savings rates have been in the doldrums for years now. This is largely thanks to the Bank of England’s eagerness to keep its base rate as low as possible.
It’s also worth knowing that rates offered on cash ISAs have typically been lower than normal savings accounts in recent years.
2. The introduction of the personal saving allowance
Following their launch, one of the biggest selling points of ISAs was that they allowed you to save tax free.
However, back in 2016, the government introduced the personal savings allowance (PSA). This allows basic-rate taxpayers to earn up to £1,000 in interest on their savings each year before having to pay tax.
The introduction of the PSA meant that ISAs lost their shine overnight. That’s because most savers earn less than £1,000 in interest each year anyway. For example, right now the highest interest rate on an easy access savings account is 1% AER variable. This means basic-rate taxpayers would have to have at least £100,000 stashed in the account before being liable for tax.
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What has happened to Cash ISA rates?
Cash ISA rates are starting to creep up, with the most generous easy access account now paying 0.85% AER variable.
Earlier this week, Santander also decided to increase its ISA rates. Following its decision, Santander 123 World or Select customers can now earn 0.8% AER variable interest with its easy access account. Meanwhile, other customers can earn 0.7% AER variable.
Should you open a cash ISA or stocks and shares ISA?
Cash ISA rates are on the up. However, it’s important to note that even the highest easy access cash ISA rate (0.85% AER) falls short of the highest paying non-ISA savings account (1% AER). So, if you are looking to save, then there’s still not much of a reason to go for an ISA over a normal savings account.
Of course, the biggest question here is whether higher cash ISA rates should make you less eager to open a stocks and shares ISA. If you have this mindset, it’s worth noting that while capital is at risk when investing, traditionally, returns from investing outperform the interest offered on savings accounts.
For example, according to Hargreaves Lansdown, stock market returns have beaten returns from savings accounts in 91% of ten-year periods over the past 120 years. This stat is perhaps even more relevant now that the UK inflation rate is soaring.
So, while it’s impossible to predict the exact returns a typical stocks and shares ISA will deliver in future, we do know that the UK’s rising inflation rate is likely to dwarf any interest earned from a bog-standard cash ISA.
Can I still open an ISA before 5 April? There is still time to act before the tax year ends. However, it’s worth taking a look at our article that explains why it’s important to avoid the last-minute ISA rush.
Please note that tax treatment depends on your individual circumstances and may be subject to change in the future. The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
