With cash ISA reform rumours circulating again, Moneyfacts data reveals higher rate taxpayers and those with larger savings pots could have made more money from top-paying cash ISAs since 2020 despite standard savings accounts paying a greater rate of interest due to their tax efficiency.

The importance of tax-efficient saving via ISAs is growing as more people shift into higher tax bands, which reforms could threaten.

Cash ISAs provide clear tax benefits for higher-rate taxpayers

Higher-rate taxpayers (40% tax rate) significantly benefit from the tax shelter that ISAs offer, especially with larger savings:

• With £13,500 saved, they avoided £282 in tax over six years, but were still £7 better off with a standard savings account
• With £50,000 saved, they avoided £3,207 in tax, making them £2,315 better off with an ISA compared to a top savings account.

Even though some traditional savings accounts offered better interest rates post-2020, ISAs remained more beneficial for higher-rate taxpayers because of the tax protection on interest earned.

For basic-rate taxpayers, the advantage depends on how much is saved

• With moderate savings (£13,500 or £20,000), basic-rate taxpayers didn't breach their Personal Savings Allowance (PSA) (currently £1,000/year), so ISAs offered no tax advantage.
• In fact, in these cases, ordinary savings accounts gave better real returns, for example, £282 better off with a savings account on £13,500.
• However, with larger deposits (£50,000), the PSA is breached, and basic-rate taxpayers would owe tax on some interest in a standard account.
• Even so, a cash ISA doesn’t become advantageous; despite saving £1,200 in tax, they are still £59 worse off in real returns over six years once the better rate of a standard saving account is accounted for.

ISA value is set to increase due to frozen income tax thresholds

The Office for Budget Responsibility (OBR) projects that by 2028–29:

• 3.5 million more people will fall into the higher-rate tax band, and
• 0.6 million more into the additional-rate (45%) band

This means more savers will benefit from using ISAs in the coming years as they become liable for more tax on their savings.

Adam French, Head of News at Moneyfacts, said:

“For much of the 2010s, ISAs were underappreciated because of rock bottom rates, and the introduction of the Personal Savings Allowance made their tax advantages feel irrelevant. But, with interest rates now back at more sustainable levels, ISAs have regained their purpose. When rates were languishing around 1% most savers didn’t earn enough in interest for tax to be an issue, but now due to the combination of frozen tax brackets and greater returns, many do. Higher rate taxpayers in particular stand to lose 40p in every £1 of interest earned beyond their £500 PSA.

“However, it hasn’t taken the Treasury long to spot that the cost to the public purse of tax-free savings has risen sharply as savers are enjoying healthier returns. Rumours of slashing the deposit limit have been regularly circulating, reportedly with the aim of getting more savers to shift their money into investments. But, in the short-term at least, reducing the amount that can be sheltered in a cash ISA is more likely to push savers into taxable savings accounts, boosting revenues for the Treasury instead.

“Whether it’s worries about inflation, stagnant wages or global instability, we are more likely to save for a rainy day than take risks with our cash. Financial security and building an emergency fund are two of the biggest reasons Brits have told us they put money away, and the reality is that millions of savers rely on the simple and secure nature of cash ISAs with their guaranteed tax-free returns to do this. Weakening this option may erode savers’ sense of financial security which risks undermining any appetite for investing excess cash.

“Instead, fostering an investment culture in the UK needs a cultural shift in attitudes towards saving and building wealth built on the back of a broader feeling of financial security.”

David Beaston, Technical Manager at TISA, writing for INTEREST by Moneyfacts, said:

“Despite the Government’s laudable objective of wanting UK savers to move towards more equity-based investing which could result in superior returns over the medium and longer term, it is TISA’s strong belief that simply reducing the cash ISA limit will not achieve this. We believe this to be a flawed logic which will simply result in more funds being deposited in taxable deposit accounts and not in stocks & shares ISAs.

“TISA believes that individuals need to be encouraged and not strongarmed into making more use of stocks & shares ISAs.”

Read more in the latest issue of the INTEREST journal, which you can sign up to receive for free here. Part or all this press release can be reproduced, so long as we are sufficiently sourced.

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