Shopping around could make your cash ISA nicer

There are ways you can boost your interest rates, says Rob Griffin

When it comes to the world of cash Individual Savings Accounts (Isas) there is good news and bad for investors. While there’s no shortage of such products available on the high street or online, the rock-bottom base rate means you will struggle to make much of a return.

However, it’s still worth shopping around because even in these rather challenging economic times there is still a big difference between the best and worst interest rates on offer, according to data compiled for The Independent by Moneyfacts.co.uk.

This study, which analysed a vast array of cash Isa accounts in early March, reveals that the most generous instant access products are offering in the region of 2.25 per cent, while those at the other end of the table are only promising a meagre 0.1 per cent.

According to Rachel Springall, finance expert at Moneyfacts, this means that the average ISA rate – which includes both variable and fixed rate products – now stands at a relatively modest 1.78 per cent, although there’s a significant disparity between providers.

“Customers would be wise to shop around for the best cash Isa deals because rates can vary substantially between the best and the least competitive,” she says. “You only get so much tax-free allowance each year, so find the best rate to make the most of your money.”

That is particularly relevant in the current climate, points out Andy Gadd, head of research at Lighthouse Group. “The simple fact is that if you earn less than the rate of inflation then you are  effectively losing money  – purchasing power – by holding it,” he says. When you consider that the consumer prices index (CPI) shows inflation is running at 2.7 per cent and the retail prices index (RPI), which includes housing costs, is at 3.3 per cent, the chances of finding a savings product that can keep pace is likely to be a challenge.

What a difference a year makes

Just over a quarter of Britons (26 per cent) now say they would prefer to invest in cash Isas as opposed to equity-based Isas, due to the riskier nature of the stock market, according to research from NS&I. This represents an increase from 21 per cent last year.

However, their enthusiasm is likely to be tempered by the fact that the interest rates on offer for these products have fallen dramatically over the past 12 months, with that Moneyfacts data showing the average Isa rate has gone from 2.56 per cent to 1.78 per cent.

Further analysis of this research reveals that the best fixed rates were offering 4.25 per cent and the worst 2 per cent in March last year. Today these figures have slumped to just 3.10 per cent and 1.7 per cent respectively.

It’s a similar story with variable rate cash Isas, although not so pronounced, with the highest rates falling from 3.16 per cent to 2.8 per cent, and the worst staying the same at 0.1 per cent. Of course, it would be hard for them to have gone down much further.

In addition, while there’s still plenty of choice in the marketplace, the number of cash Isas available has actually dropped over this period. In March 2012 there were 153 variable cash Isas and 149 fixed, whereas today there are 134 variable cash Isas and 105 fixed.

The rules governing cash Isas

Despite the lacklustre rates on offer, it still makes sense for people to hold their cash in an Isa as opposed to a basic bank or building society account to avoid any tax implications, according to Kevin Mountford, head of banking at Moneysupermarket.com.

“An Isa should be the first account you open and the last one you close,” he says. “People should use their annual allowance because it will be cost effective for them.”

They are available to those who are at least 16 years old who can currently invest up to £5,640 of the total £11,280 annual allowance. Only one cash Isa can be used in any tax year. This will be rising to £11,520 from 6 April, 2013, with up to £5,760 eligible for a cash Isa.

The main benefit of having a cash Isa is that your provider will – in most cases – pay you a rate of interest in exchange for your money in exactly the same way as a normal savings account, with the added benefit that you won’t have to  declare any of your gains to the taxman. You will be entitled to keep everything that you receive from that investment without having to pay any tax on it. This is not the case, for example, with an ordinary bank or building society account, unless you are a non-taxpayer.

How to make your choice of a cash Isa

Remember to make your investment decisions as early as possible in a given tax year so that your money has the maximum amount of time in which to work on your behalf. Every day procrastinating is a day of lost interest.

For those wanting a cash Isa the choice will be between fixed and variable rate products – and it’s a decision that comes down to the needs and preferences of the individual, according to Mr Mountford.

“Fixed rate gives people the comfort that their money is locked away on a guaranteed interest rate for a set amount of time, whereas an easy access account suits those who need to dip in and out of savings whenever they want,” he says. “Interest rates on easy access Isa accounts are variable – so it is important to keep an eye on it and move your money if it becomes uncompetitive.”

Keep moving to get  the best deals

However, it’s not just your new annual allocation that you should be worried about but cash Isas in which you’ve saved in previous years as well, according to Carl Melvin, managing director at Affluent Financial Planning,

“Investors need to check any currently held cash Isa accounts to see if they are competitive – and if not then consider transferring to a better one,” he says. “With cash ISAs it’s about the rate payable, the access terms, and the financial strength of the provider,” he says.

It’s certainly worthwhile, agrees Justin Modray, founder of the website Candid Money, who points out that even on a basic £5,640 contribution the difference in annual interest between the best and worst payers can be more than £100 – and substantially higher for those with more savings.

“If you have existing variable interest cash Isas the chances are that the rate will be rather less attractive now than when you took it out,” he says. “Therefore, don’t hesitate to transfer to a better deal if you can find one elsewhere.”

It’s a straightforward process – as long as you follow the rules. If you want to switch, therefore, make sure you speak to your provider about arranging a transfer because if you withdraw the cash yourself it will lose its tax-free status.

Read the small – and not  so small – print

Neil Mumford, a chartered financial planner with Milestone Wealth Management, warns that investors need to take a close look at what’s on offer. “High headline rates are being offered to attract investors which are normally made up of a one-off bonus,” he points out.

When you’re looking around, check to see whether an Isa provider will accept transfers in or transfers out, because if they don’t then you may end up with separate Isa pots for each tax year, which might not be ideal for your situation.

You will also need to read the small print. Some providers may levy exit fees which can very well outweigh any anticipated uptick in the rate being given. Take your time and consider your options before making any such moves.

If you’re opting for a variable rate cash Isa, then make sure there are no withdrawal restrictions, adds Kevin Mountford, and if you prefer fixed rates, then bear in mind that long-term products don’t seem to offer great value at the moment.

 “People need to make sure they can afford to lock their money away because most fixed cash Isas won’t allow you to withdraw anything before the end of the term, and even those that do will levy a penalty at you for doing so,” he says.

Getting the right deal for you

l Decide what you want. Are you happy to lock your money away for a number of years in exchange for a higher rate of interest or is being able to get instant access to your cash more important?

2 Explore your options. Find out what rates are being paid by other accounts. Comparison websites such as Moneysupermarket.com can be ideal for this purpose as they give you a snapshot of the market, including fixed and variable rate interest products.

3 Consider the small print. Rates may look great but many will be inflated by short-term bonuses and some have constraints such as not accepting transfers from previous Isa investments, so make sure you understand exactly what is on offer.

4 Apply to transfer. Don't just withdraw your money as it will lose its tax-free status and be treated as fresh money when you re-invest. You will need to apply to transfer the funds which your new provider can arrange.