Falling Interest in Cash ISAs
Typically, the end of the tax year brings with it a flock of people opening or topping up cash ISAs to make the most of their yearly tax-free allowance; however, studies have shown that over recent years fewer people are making the most of their ISA allowance. According to data from the Bank of England, £4.8 billion was withdrawn from cash ISAs in the last 6 months of 2020, the highest outflow on record.
Low Interest Rates
The amount of interest a provider will pay usually relies on the Bank Rate set by the Bank of England and can also be referred to as “the Bank of England Base Rate”. When the base rate changes, this typically means that the amount of interest providers pay to consumers will follow suit; however, this does not mean the offered interest rate will be the same as the base rate. It will often be lower to allow providers to cover any costs.
In March of last year, the Bank of England slashed their base rate to 0.1%, as you can see from the chart below, this is a significant decrease; in fact, it is the lowest it has ever been in UK history.
With interest rates at an all-time low, it’s no surprise that fewer consumers are opening cash ISAs; with a review of the base rate due on the 6th of May, there is hope that soon interest rates will rise, and consumers will start saving again.
The Coronavirus Pandemic
The Covid-19 pandemic has had a significant impact on most consumers’ financial situation; with a vast number of job losses and people on furlough on a reduced income, there are fewer people with money to save.
The pandemic has also impacted providers; as mentioned above, in an attempt to reduce the economic impact of the pandemic, the Bank of England made the emergency cut to the base rate.
Personal Savings Allowance
The Personal Savings Allowance (PSA) launched in 2016. It is a tax-free allowance that gives consumers the ability to earn interest on any savings without paying tax, dependent on income tax rate. The current PSA’s are
|Income Tax Bracket||Allowance|
|Basic Rate – 20%||Can earn £1,000 in interest per year without paying tax.|
|Higher Rate – 40%||Can earn £500 in interest per year without paying tax.|
|Additional Rate – 50%||No allowance given|
The introduction of PSA could be a leading cause of the decline in consumers making use of their ISA allowance; whilst ISAs are still popular among the higher earners, who are most likely to have more considerable savings and do not receive a personal savings allowance; those earning less and on basic rate tax are less likely to earn over their PSA in interest. The Bank of England statistics show that the number of cash ISA subscriptions has fallen 30% since PSA was introduced.
With current interest rates, the majority of people won’t earn over their PSA in interest; in fact, in a recent survey from the Yorkshire Building Society, two-fifths of those asked felt there was no point saving in an ISA when you fall under the PSA. However, when interest rates do eventually rise, more people may need to make use of both their PSA and ISA allowance.
Is there a Lack of Understanding when it comes to ISAs?
ISAs have been around now for more than 20 years, but despite this, research from the Yorkshire Building society found that many consumers still do not fully understand the cash ISA rules, with uncertainty around allowances, transfers and withdrawals.
One of the main benefits of ISAs is that they are flexible, whilst there are some ISAs that require the consumers to give a specific period of notice if they wish to withdraw money, the majority of cash ISAs give easy access.
The study found that 18% of people believed that once they had opened an ISA, they were unable to transfer it to another provider. Consumers can move from one provider to another at any time to the same or different type of ISA. This allows people to make the most of competitive interest rates.
Are People Turning to Other Types of ISAs?
Cash ISAs are not the only ISAs available, Investment, Lifetime and Peer-to-Peer ISAs are less affected by falling interest rates and can look more appealing to consumers.
An investment ISA, also often referred to as a stocks and shares ISA follows the same rules as a cash ISA in that it offers consumers tax-free investing, with a limit of £20,000. However, with an investment ISA, instead of earning interest, customers money is invested into stocks and shares, which they can either select themselves or use a ready-made portfolio. Whilst Investment ISAs can be risky, they have gained huge momentum over recent years, largely due to the far higher potential returns. According to Interactive Investor, 35% of transfers into stocks and shares ISAs in 2020 came from cash ISAs.
The Lifetime ISA replaced the Help to Buy ISA in 2017; there are some big differences in the rules for lifetime ISAs when compared to other ISAs, for starters, the Lifetime ISA is only available to people aged over 18 and under 40. Consumers can save up to £4,000 a year, and the Government will add 25% on top. There are also strict rules about when cash from lifetime ISAs is allowed to be withdrawn, consumers have to be either over 60, or use the money for buying their first home, else they will be subject to a 25% penalty.
The introduction of the lifetime ISA could easily be a contributing factor in the decline of the cash ISA; where people would normally be using a cash ISA to save for a deposit for a house, or potentially for retirement, the lifetime ISA with the government bonus may well seem more appealing.
Peer-to-Peer ISAs, also referred to as Innovative Finance ISAs (IFISAs), are like other forms of P2P lending and provide a way to bring together those looking to invest money and those looking to borrow money. Like all other types of ISAs, IFISAs are tax-free and included in the £20,000 allowance. Essentially, when a consumer invests in a P2P ISA, the money is lent to borrowers and businesses, who then pay the money back with interest. The downside to IFISAs is that they are not covered by the FSCS, though some platforms will offer protection if the borrower defaults on their loan and IFISAs are still regulated by the FCA.
P2P ISAs can often offer a higher rate of interest than cash ISAs, but the return is not guaranteed, and capital can be at risk, so this type of ISA is not suited to everyone.
Is this the End for the ISA?
The future of cash ISAs may currently look uncertain, but in time, interest rates will increase and more consumers will once again look to cash ISAs for their savings; and whilst there has been a decline in the number of people choosing to take out a cash ISA, £72 billion was still deposited into cash ISAs in the last 6 months of 2020.