A Cash ISA – or Individual Savings Account - is one of the many types of ISA now available. It is a straightforward savings product, which means that your money remains as cash, rather than being used to buy an investment – as is the case with Stock and Shares ISAs.
Like other ISAs, the Cash ISA allows you to save free of tax. Paying tax on the interest your money earns reduces the level of returns you receive, and the rate at which it can grow. An ISA lets your money can grow faster, as there will be nothing to pay to the taxman while your money is inside it and no income or capital gains tax to pay when you come to take it out.
Many providers such as banks and building societies offer Cash ISAs, which work much like a conventional savings account. You can pay in a lump sum each year, pay in when you have some spare cash - or with many providers make regular monthly savings direct form your bank account with a standing order.
Like a conventional savings account, you will receive a passbook, or more common these days a certificate and online access to help you keep track of your money.
When the time comes to take your money out, you can do so – free from any tax penalties. You don’t even need to disclose your ISA on your tax return.
The tax advantages of an ISA are so valuable that the government has set strict rules on how you can use them. The most important are the limits on what you can pay in. So, you along with everyone else over the age of 18 have an annual ISA allowance which sets a limit on what you can put in. For the 2020-21 tax year, it is £20,0000.
This means two things:
The limits are strict, but remember, even if you have to stop paying into your Cash ISA the money you have already put in can keep growing. What’s more, you can make new payments into the same account as soon as the next tax year starts.
There are also some rules about who can have a Cash ISA – although they are broad. All UK residents aged 16 or over can have a Cash ISA, and so can crown employees serving overseas.
There's no limit for how many Cash ISAs - or other types of ISA - you can have overall. But you can only pay into one of each kind of ISA in the same tax year. This means you can only make new deposits into one Cash ISA each year. There would be nothing to stop you opening a fresh Cash ISA each year, but you might find it better to simply have just one and pay into it year after year.
The old Help to Buy ISA counted as a Cash ISA option under this rule, but the Lifetime ISA which has replaced it does not – so you can pay into both a Cash ISA and a Lifetime ISA in the same year, although both will count towards the £20,000 annual allowance.
Once your money is inside an ISA, you may be able to move it to another. So, if you have already paid into a Cash ISA from one provider and see a better rate on the market, you may still be able to take advantage of it by transferring your ISA funds. If you're moving money saved in previous tax years, you can to move all or part of it to a new ISA without affecting your allowance for the current tax year. However, if you want to move money you've paid in the current tax year, you must move all of it. Not all ISAs accept transfers, so be sure to check before you apply.
This also means that you can transfer your money into another type of ISA if you wish. Transferring your savings into a Stocks and Shares ISA may give you potential for better returns but will still give you ISA tax protection for your money - although it will mean your savings become an investment and will therefore be at risk. You could transfer your funds form an underperforming Cash ISA to an Innovative Finance ISA and enjoy the prospect of better returns and better security for your funds. Although this alternative is riskier and does not include FSCS protection.
ISA saving is simple, and once you have chosen your ISA and made your contribution you watch your money grow without needing to do anything more.
But not all ISAs offer the same level of rewards. Some will offer much better rates than others, which could make them a better choice for you and your ISA allowance.
You can look at online comparison tables to see which offer the best rates, just as you can with conventional savings accounts. But whatever you choose, you may find the returns a little disappointing.
The problem is that as savings plans, Cash ISAs cannot offer very exciting returns in the current world. The Bank of England interest rate is very low which means many Cash ISAs offer lower returns than the rate of inflation.
It is a problem shared with ordinary savings accounts. Of course, the ability to offer tax-free growth of your money should still give a Cash ISA an advantage over ordinary savings accounts, but there is a complication.
Since 2016 we have all had a personal savings allowance from the taxman, which means that most of us can earn £1000 interest on our savings before we have to pay any tax on it. (Higher rate taxpayers have a £500 allowance). With current low interest rates, this means that most of us will not earn enough interest to gain any advantage from having a Cash ISA. The taxman will not eat into our interest whether we earn it in an ISA or a savings account.
In the long term, a Cash ISA can still be a good choice, because you will never have to pay tax on the cash in it however large it grows – but for the short term you may be no better off.
The answer may be to choose a different type of Cash ISA altogether – an Innovative Finance or IF ISA. With an Innovative Finance ISA capital is at risk.
There are actually several type of Cash ISA and choosing the one that is right for you may depend on your priorities. With a Flexible Cash ISA or Instant Access Cash ISA, you can withdraw and replace savings as required, making this the ideal choice if you need the freedom to access your money easily. You must return the cash you take out within the same tax year, or you could lose its ISA status.
Fixed-Term Cash ISAs may be able to offer better interest rates, but in exchange they will mean locking your money away. They're only a good choice if you are certain that you can afford to leave the money untouched.
But you don’t have to make a lump sum contribution. If you want to save monthly a Regular Savings Cash ISA might be a better fit.
You can also get Cash Lifetime ISAs.
But there is a more radical alternative. An Innovative Finance ISA sits between the safety, but low returns, of a Cash ISA and the potentially large returns, but volatility of a Stocks & Shares ISA. Your money is lent directly to borrowers, rather than paid into the funds of a conventional provider such as a bank. Like a Stocks and Shares ISA the IF ISA is not covered by the Financial Services Compensation Scheme and your capital is at risk.
You can open a RateSetter IF ISA or transfer your existing ISA funds.
Please note that tax treatment depends on individual circumstances and may be subject to change in the future. ISA rules apply. Capital at risk. No FSCS protection.