Tax-free saving
If you are a taxpayer who wants to get into make the most of their savings, a cash Isa (individual savings account) should be your first port of call. This is because cash Isas offer a tax-free way of saving, so any interest you earn is paid without tax being deducted, unlike the interest earned in everyday savings accounts.
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All you need to know
Cash Isas are available to anyone over the age of 16 from most banks and building societies. However, children can also start saving into a Junior Isa.
Because of the tax-free status, cash Isas will give you a better rate of return than a standard savings account. Although many cash Isas pay a similar interest rate to standard savings accounts, the rate you actually receive is much better as you receive the interest free of tax. For example, if you had a standard savings account paying 3%, as a basic rate taxpayer, you would actually only receive 2.4%. If you are a higher rate taxpayer you would only earn 1.8%. In comparison, a cash Isa paying 3% would receive the full 3%.
For the 2012/13 tax year, you can put a total of £11,280 into an Isa. Out of this, a maximum of £5,640 can be put into a cash Isa. The remainder, or the full £11,280, can be put into a stocks and shares Isa if you would prefer to have your money invested in the stock market. If you don't use this limit up, you simply lose it.
EXAMPLE
You pay £5,640 into a cash Isa paying 3%. After one year, you'd receive £169.20 in interest.
If you put the same amount into a standard savings account paying 3%, you would only receive £131.98 as a basic rate taxpayer or £101.52 as a higher rate taxpayer.
If you can, try to avoid paying in your full allowance at the end of the tax year which runs until 5 April each year. If you can put in your full allowance the minute the new tax year starts, you'll see the full benefits as the example below shows.
EXAMPLE
If you put the full £5,640 in a cash Isa paying 3.06% on 6 April 2012, you'd have an extra £172.58 by 6 April 2013.
But if you only put in the full allowance on 6 March 2013, you'd only have £14.18 in interest by 6 April 2013.
Withdrawals
If you invest the maximum amount and then choose to withdraw funds you cannot then top up your Isa at a later date as you have technically already invested the full amount. This also applies to smaller amounts. Say you have already paid in £4,000 and later withdraw £2,000 - in this case you won't be able to put the full £2,000 back. Instead, you can only pay in your remaining unused limit of £1,640.
You should also note that you can only open one cash Isa each tax year, but you can switch the funds at any time to take advantage of better paying accounts.
However, if you are going to move to a better deal, be aware some cash Isas do not allow transfers.. You should also not withdraw yourself the money you want to transfer. If you do, it will lose its tax-free status so tell your new provider t you would like to transfer money from an existing cash Isa and fill out a transfer form. You may also need to send a form or letter to your old provider, but otherwise the new provider will make all the arrangements for you.
Different types
There are various different types of cash Isa available on the market.. A fixed-rate Isa will generally offer you a higher interest rate because you are investing your money for a longer period of time. You can invest for one, two, three, four or five years. But you won't be able to access your money until the term has finished. The advantage is the rate is fixed so you won't have to worry about the interest rate dropping. On the flipside, you should also be wary about tying up your money for too long. If you have tied your money up for four or five years and interest rates rise during that time, you may find your cash Isa is no longer competitive.
In comparison, easy access cash Isas are more flexible and allow you to access your funds should you need to. However, they do come with a variable interest rate so the rate could change at any time. There is often a bonus rate attached which temporarily inflates the overall interest rate – usually for 12 months. This means once the rate expires, you will need to move your savings to a better account.
