Happy new ISA year

HAPPY New Year. The new financial year that is – it started this month.

The main cause for celebration is that everyone over 16 can now save £5,100 in a new tax-free cash ISA.

While ISA rates have had a justifiably bad press recently, know what you’re doing and they still vastly outpay the best savings accounts.

The basics – what are Individual Savings Accounts (ISAs)?

For a decade now, whether it’s on telly, radio, in books or on my website, I’ve used the same analogy to explain ISAs. It works, so forgive me if I bring out “the cakes” again.

Just imagine you have got a couple of cakes: one chocolate (representing cash) and the other strawberry (shares). Now picture the taxman picking up a slice and takes a bite from it. Yet each year, to encourage saving, you’re given a tax-free ISA wrapper, a bit like cling-film, that you can put around some of the cake.

Once inside the cling-film, the cake hasn’t changed. The chocolate is still chocolate (cash is still cash) and the strawberry is still strawberry (shares are still shares). The only difference is that, once inside the ISA, the tax man can’t bite it.

How do cash ISAs work?

The cash element of ISAs is simply a tax-free savings account, and you can take your money out whenever you want. This year, for the first time, everyone will be allowed to put £5,100 in one – and, importantly, once the money’s in, it stays tax-free year after year.

That has a real impact. Normally, basic rate taxpayers hand over 20 per cent of their savings interest to the tax man (higher rate taxpayers 40 per cent), so keeping cash in an ISA boosts your take-home interest by a quarter (two thirds for higher rate taxpayers) and this gain compounds each year. The problem is many providers take this gain for themselves, by offering low rates like 0.1 per cent. Yet you can avoid that...

The Top Paying Cash ISAs

Top Easy Access Deal – 3.2 per cent with rate guarantee: the current easy-access best buys are sister banks Alliance & Leicester and Santander, whose Flexible Cash ISAs pay 3.2 per cent AER and guarantee to be 2.7 per cent points above base rate for the first year. This means that if interest rates rise, so will what you’re paid.

However, after a year the rate plummets, possibly to just 0.5 per cent. So get one, but put the anniversary in your diary, and then simply transfer it to a better paying deal then.

Next stop is Barclay’s Golden ISA, which pays 3.1 per cent AER, though one per cent of this is a bonus lasting 12 months.

Top Fixed Rate Cash ISAs – up to 3.75 per cent: if you’re prepared to lock your cash away, you can earn more with a fixed rate cash ISA, the Halifax offers a two-year fix at 3.5 per cent AER or three years at 3.75 per cent AER.

Once your money is in one of these fixed rate ISAs, there are big penalties for taking it out. If interest rates were to rise so your fixed rate no longer looked competitive, it would cost you to move to a better rate elsewhere.

More options at moneysavingexpert.com/cashISAs.

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Your questions answered

Q IF I take cash out do I lose the tax benefit?

AYou can take money out whenever you want, without any tax impact. Once outside an ISA, the cash isn’t tax-free any more, but you don’t have to give back the tax gain you made while it was in there. The key rule though is that once the money has been withdrawn, it can’t be returned. An example will help. Say you put in £3,500, leaving you able to put in a further £1,600.

Then in a couple of months you withdraw £2,000. That has absolutely no effect on how much money you can put into the account. You can still only put £1,600 back in.

Q How many cash ISAs can I have?

A As many as you want, but only one for the current tax year’s cash ISA. You get a new ISA allowance each tax year, so even if you have opened an ISA before, unless you did it this week, you’ve still got your full 2010/2011 allowance to use. That means you can open a new ISA, and it doesn’t have to be with the same provider you used previously.

Q Can I still put money in last year’s ISA?

A No, that year is closed. If you don’t use your allocation within the year, you lose it. If you try to do so, it’ll simply count as opening up this year’s allowance with your old provider.

Q What if my old ISAs are earning diddly squat?

A Transfer them. The best paying cash ISAs that accept transfers are at 2.75 per cent AER, so if you’ve big money saved, it could be a massive boost. See moneysaving expert.com/isatransfers for all the best deals. Yet beware: don’t just take your money out to transfer, as then it’s no longer an ISA. Open the new ISA first and ask it to transfer the money across for you. A few ISA providers charge a penalty if you transfer out; do check, as it can diminish the gain.

Q Are cash ISAs safe?

A You get the same £50,000 per person per financial institution savings protection as any other savings, provided it is in a UK regulated account (all those listed here are). The fact that it’s in an ISA and you have more than that will not give you extra protection, but provided your combined savings in an institution are under £50k, you will be protected. Yet always check it is definitely UK-regulated. For example, shockingly, Post Office Savings is not. It’s provided by the Bank of Ireland, so your protection is from the Irish, not UK, state.

Q I’ve already got a Santander ISA with a terrible rate, why do you say it’s a best-buy?

A Like many banks, Santander has a large array of cash ISAs.

The best-buy is specifically its Flexible Cash ISA, but that doesn’t mean you are getting a decent rate with its other products (transfer out if not). It’s about the specific product, not the provider.