To the surprise of no one the Bank of England kept interest rates on hold last week, marking the fifth anniversary of the cut to the all-time low of 0.5 per cent.
That means savers have struggled for 60 months to find anything approaching half-decent returns for their nest-eggs. In fact if you’ve let your cash languish in a 0.5 per cent paying account, the interest you’d have earned would be paltry.
If you had £5,000 in an account paying 0.5 per cent you’d have earned just £126.26 in interest. If you had an account paying 2.5 per cent you’d have earned a much more healthy £657.04.
But even at that rate you’d have lost out in real terms as inflation ravages the buying power of your cash. While inflation actually fell to 1.9 per cent last month, for most of the past five years it’s been nearer the 3 per cent mark, meaning that it’s been nigh on impossible to find a savings deal that beats it.
The only real way to hope to beat inflation has been to use an individual savings account (ISA). And the only reason that some ISAs have outstripped inflation is down to one word – tax.
Because you pay no tax on the gains on money in an ISA, the returns you get are gross. So while in a standard savings account interest is paid after 20 per cent tax has been deducted, there’s no tax in an ISA.
In short, if an ISA promised 3 per cent interest that’s how much you’d get. Normal savings accounts would end up paying just 2.4 per cent after tax. However, if you’re a higher-rate taxpayer the situation is even worse. Your 3 per cent would actually only net you 1.8 per cent after tax.
That should neatly demonstrate the argument for using an ISA, especially as they are as flexible as ordinary accounts in that you can get your cash any time you need it.
However, because it’s a tax-free account there are rules you have to stick to. One of them is that you have an annual ISA allowance. With the end of the tax year approaching it means if you don’t use your 2013-14 allowance you will lose it.
You must do so by 5 April and you can put up to £11,520 in an ISA. There are two types: a stocks and shares ISA into which you can use your whole allowance, or a cash ISA into which you are only allowed to stick up to £5,760. However, you can then put the rest of your allowance into a shares ISA.
Clear? In short you can use half your allowance in a savings account but if you want to use it all, you’ll have to put it into funds or shares.
So if you’re convinced of the advantages of ISAs then which should you choose? If you want a savings ISA then whichever pays the best rate is the most logical home.
But you do need to check the restrictions, especially if you may need to get at your cash. Some fixed-rate ISAs require you to lock your cash away for a year, for instance.
The banks are beginning to reveal their offerings for the end of the current tax year, but to date they haven’t been terribly tantalising.
Santander launched its new range on Monday with its main offer a two-year, fixed-rate deal paying 2 per cent. Sound a little dISAppointing? Anna Bowes of Savingschampion.co.uk agrees. “The launch of the Santander Cash ISAs is usually an indication of how the ISA season will progress,” she says. “Unfortunately, this year it has confirmed fears that providers’ appetite for savers’ cash remains limited.”
Halifax topped the deal yesterday with an 18-month ISA paying 2 per cent. That’s slightly more attractive, and is based on the belief that rates will rise soon after next year’s general election.
There are two things to bear in mind, though. First is that other ISA providers may come in with better offers before the 5 April deadline.
Second is the fact that to beat a 2 per cent tax-free ISA, you’d need to find a standard savings account paying 2.5 per cent. The highest I could find from a mainstream provider was Halifax’s Fixed Online Saver – which pays just 1.6 per cent.