Is it time to turn your back on Isas?
The tax-free choice for savers is losing its appeal with poor interest rates, but other accounts have drawbacks too, says Chiara Cavaglieri
Saturday 22 February 2014
Things usually pick up for savers in the run-up to a new tax year, but so far the cash individual savings account season has been a desperately disappointing affair. If you're waiting for the market to pick up, you could be waiting in vain, but should you really be looking at regular savings accounts instead?
There is no doubt that regular savings accounts offer, at first glance, heavyweight interest rates. The current best buys from First Direct and Marks & Spencer bank pay an appealing 6 per cent, while HSBC and Saffron Building Society follow with rates of 4 per cent apiece. Regular savings accounts can be a useful part of a saver's armoury. Not only do they encourage a disciplined approach to saving – you must typically save between £25 and £250 per month – but they can also work well if you drip feed cash from another savings account.
Turning to cash ISAs, there is really nothing to shout about. Top of the best-buy tables is the Select Access Cash ISA 2 from Britannia paying 1.75 per cent AER, but this must be operated by post or branch and only allows two penalty-free withdrawals each tax year. The variable National Savings & Investments Direct ISA also pays 1.75 per cent but the rate is due to drop to 1.50 per cent next week.
If you're willing to lock your money away, Britannia pays 1.85 per cent fixed until 30 January 2015 and 2.05 per cent fixed until 31 January 2016 (if you are not transferring in previous years' ISAs, you must deposit the full ISA allowance of £5,760). The Virgin E-ISA pays a more generous 2.4 per cent but you won't be able to access your savings until 24 January 2017, during which time rates could improve considerably.
Compared with even the best ISA rates, regular savings accounts paying 6 per cent sound too good to be true and of course, in many ways they are. The clue is in the name – you do earn impressive rates but only on monthly saving up to a specified limit (typically from £25 per month). It takes a long time to build up a decent pot of money from which to reap the benefits of the high interest rate.
Kevin Mountford, banking expert at Moneysupermarket.com, says: "Due to the fact you only deposit small sums on a monthly basis, the interest you will actually receive will be lower than advertised."
The First Direct account pays 6 per cent fixed for one year but only allows deposits of between £25 and £300 each month. Even if you were to put away the maximum each month, you only earn a full 12 months' interest at 6 per cent on the £300 you save in month one. By month two, you earn 6 per cent on £600 but only for 11 months and so on. Over the year, the total interest earned is actually £115 and that's before you lose a chunk to basic or higher rates of tax. If you were instead able to earn 6 per cent on a lump sum of £3,600 for a year, you would reap a far more appealing £216 after a year.
"In order to maximise the returns, it is best to open a market-leading savings account, hold your savings in this account and drip-feed the maximum deposit into the regular saver each month," says Mr Mountford.
As well as fairly misleading advertised rates, many of the best regular savers are restricted to existing customers. With First Direct, M&S and HSBC, you must be a bank account customer to open their respective regular savers and these current accounts have their own baggage (the M&S Premium Current Account costs £10 a month).
Most providers impose other conditions including penalties if you miss any monthly deposits or withdraw cash. For example, if you miss a payment or make a withdrawal from your First Direct regular saver, the account is closed and you earn a paltry 0.5 per cent interest instead. Most of these accounts are only good for one year, after which the interest falls away entirely.
If you look at the actual figures, the first port of call is still an ISA for the tax-free status.
Put away a lump sum of £3,000 (equivalent to £250 per month) in a fixed-rate ISA paying 1.85 per cent and you would earn £55 interest at the end of that year. Looking at the table of regular savers, only First Direct and M&S would get better results for a basic-rate taxpayer.
The perks with many of the top current accounts can't be ignored either. Nationwide's FlexDirect account pays 5 per cent on balances up to £2,500 for the first year and the Halifax current account offers an initial £100 switching bonus as well as a perk of £5 per month for every month that you deposit £750.
Jafar Hassan, personal finance expert at uSwitch.com, says: "Luckily, current accounts are offering consumers a lifeline.
"With rates of up to 5 per cent, it's no surprise that savvy savers are turning their backs on ISAs."
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
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