Has the tax-free savings Budget reform killed the cash Isa?

Around 28 million savers are set to benefit from a radical overhaul of High Street accounts announced in last week’s Budget.

From next April, every basic-rate taxpayer will be able to earn £1,000 interest a year without having to pay tax. Higher-rate taxpayers will be able to earn £500 interest.

Effectively, this means that for 95 per cent of savers all interest in High Street savings accounts will be paid tax-free — giving them a 20 per cent boost.

It’s a truly radical overhaul to the way we save — so what should you do to prepare?

How your savings interest is taxed

Every year every adult can save £15,000 (£15,240 from April 6, 2015) into a cash Isa, where interest is paid tax-free.

But, currently, when you save into a High Street account the interest is taxable at your normal rate.

Banks and building societies automatically deduct basic rate tax of 20 per cent before your interest is paid out and pass it directly to HM Revenue & Customs.

Higher earners paying 40 per cent or 45 per cent income tax have to declare the interest they receive on a self-assessment form. Lower earners who don’t pay income tax can fill in a form to stop the tax being deducted.

These deductions mean that someone with £20,000 in a High Street savings account paying 2 per cent would earn only £320-a-year interest if they were a basic-rate taxpayer.

A higher-rate taxpayer would earn £240 and a top-rate taxpayer £220.

If the interest was untaxed, the saver would earn £400.

Someone who earns less than the personal tax-free earnings allowance of £10,000 (£10,600 from April 6) can fill out a form, known as an R85, to stop tax being deducted at source.

From April, those with total income of less than £15,000 (£15,660 if you were born before April 6, 1938) can also qualify for tax-free interest on their savings.

What’s going to happen in future?

From April 6, 2016, banks and building societies will stop automatically deducting interest from your savings. It will all be paid tax-free.

Those who earn below £16,800 a year won’t have to pay any tax on savings interest.

This is because they’ll benefit from the £10,800 personal allowance, the abolition of 10 per cent tax on the first £5,000 income for low earners and tax-free interest up to £1,000.

Meanwhile, anyone earning below £42,700 — the point at which higher-rate tax starts — will be allowed to have £1,000 in savings interest tax-free.

Those with earnings from £42,701 to £150,000 will have a £500 allowance.

Anyone earning more than this, and paying the 45 per cent tax band, has to pay tax on their savings interest.

For basic-rate taxpayers, it means that savers can effectively have £74,000 in the top easy-access account — 1.35 per cent from Virgin Money — and pay no tax on the £999 interest. For a married couple that’s no tax on your first £148,000 worth of savings.

A higher-rate taxpayer would be able to have savings of £34,000 before they faced tax. Above the limit, savers would have to pay tax on their interest at their normal rate.

This will mean either putting it on your self-assessment tax form or HMRC adjusting your tax code.

Is this the end of cash Isas? Don’t ditch them just yet

In the short term this could make cash Isas suddenly seem identical to an ordinary High Street account.

Another change in the Budget means savers can soon withdraw cash from an Isa and put it back in again without using up their annual allowance.

This means that your ordinary Isa will work in practically the same way as an ordinary savings account.

But fail to use your Isa allowance today and you could well regret it.

You’ll notice the difference between the two types of accounts if interest rates do go up.

 When that happens — which may not be for some time — £1,000 of interest tax-free may suddenly seem far less generous.

In an account paying 3 per cent, it would mean savings of £35,000 would put someone over the limit as a basic-rate taxpayer. 

And at 4 per cent, it would be £25,000.

If this happens, savers will want to have as much money as possible in a cash Isa where all their interest will still be tax free.

If savers don’t use their annual allowance up they still lose it. For example, if you pay only £1,000 into a cash Isa this year, then that is £14,000 of allowance you won’t get back.

And there is another argument why you may want to stick with your Isa.

Patrick Connolly, from independent financial advisers Chase de Vere, says: ‘I recommend still using your cash Isa allowance.

‘You don’t pay any extra in charges and the interest is likely to be tax-free for a very long time.

‘There is more chance of changes to the new £1,000 personal savings allowance and tax rates than the Government introducing tax on what you have saved so far in your cash Isa.’

A worry is that cash Isas may now become redundant and offer only duff rates.

That’s not the case at the moment, but if it starts to happen, you can rely on Money Mail to keep you up to speed.

What should I do next?

The new tax allowance doesn’t kick off until April 2016. So you need to use your cash Isa allowance to get tax-free interest until then.

Radical: Chancellor George Osborne

By using your £15,000 Isa allowance for this tax year — which ends on April 5 — and the £15,240 for the new tax year, which starts the following day, you can save £30,240 and earn tax-free interest.

On top of the tax boost, you can benefit from higher returns. Banks and building societies generally pay higher rates on cash Isas than on taxable accounts.

On the full £15,000 allowance for this tax year you will get £153 extra interest for the year if you pick Barclays Instant Cash Isa at 1.39 per cent over its Everyday Saver, where the rate is a measly 0.46 per cent before.

HSBC current account holders who qualify for its Loyalty Isa can do even better. The bank’s Loyalty Cash Isa pays 1.5 per cent, plus an extra £10 a month interest to Advance current account customers, 1.6 per cent on Premier account and 1.4 per cent to its other current account holders.

Even at the lowest rate you will still see £204 more interest than in its Flexible Saving, which pays a pittance of 0.05 per cent. 

Put in a full £30,240 — the total of this year and next year’s allowance and you’ll make an extra £279 with Barclays Isa accounts and £411 with HSBC.

Other top-paying cash Isas include Post Office Premier Isa, Skipton BS Bonus Isa and National Savings & Investments Direct Isa all at 1.5 per cent — or £225 interest on £15,000.

Fixed-rate Isa deals also come out on top compared to taxable accounts.

Nationwide pays 1.45 per cent on its two-year, fixed-rate bond and 1.65 per cent tax free on its cash Isa version.

Anna Bowes, of analysts Savingschampion, says: ‘It’s a good idea to use your cash Isa allowance so if and when interest rates rise that tranche of your savings won’t eat into your new £1,000 personal savings allowance.’

What are the other options?

With rates at such low levels, some savers could do better in the short term with their current account.

For example, Santander pays 3 per cent before tax on balances up to £20,000 — more than you can earn on the top easy-access cash Isa. And TSB pays 5 per cent on balances up to £2,000.

What about families? 

If you’re married, or in a couple where one of you is a higher-rate taxpayer and one a basic-rate payer, it could make sense to put all your savings into the name of the lower earner.

This particularly applies if you’ve got more than £34,000 in High Street accounts, as this would earn around £500-a-year interest and so the higher-rate earner would start having their interest taxed.

Alternatively, the higher-rate payer could just keep extra savings in their Isa if they had not used their allowance.

However, what hasn’t changed is the benefits for children. Currently, children can earn only £100 in interest tax-free on money put into a savings account for them by parents.

And although under the new rules children will benefit from the tax-free interest allowance that most taxpayers will get, they will still be limited by the same £100 cap on tax-free interest on money paid into their account by their parents.

This means parents (and step-parents) can gift their children as much money as they like, but the child can still earn only up to £100 in interest in a year tax-free from any money given to them by each parent — a total of £200 in a tax year.

If it goes over this limit, the whole amount — not just the interest earned over the £100 limit — is taxed at each parent’s normal rate.

Money given by grandparents and other adults does not suffer this cap. Adults can also put £4,000 into a junior cash Isa or child trust fund for their children this tax year and the interest is tax-free. The limit rises to £4,080 from April 6.

How will this affect National Savings?

The new tax-free interest personal allowance will mean a change to the way you are taxed by National Savings & Investments, too.

If you buy the 65+ Guaranteed Growth Bonds between April 6 and May 15 —when these Pensioner Bonds will be withdrawn — interest will be paid before any tax is deducted.

But non-taxpayers who have already taken out a one-year version of the bond will have to reclaim the tax using an R40 form. And if you have already taken out a three-year bond, you will also have to claim tax back on the first lot of interest added to your account.

Until April 5 next year, interest on these bonds will be added or paid out after 20 per cent tax has been taken. Interest added from April 6 next year will have no tax deducted. The same — where tax will no longer be deducted from April 2016 — will apply to Guaranteed Growth and Guaranteed Income bonds.

With other NS&I accounts, there will be no change. Interest is already paid before any tax is taken on its easy-access Investment Account paying 0.75 per cent and on Income Bonds.

You will also continue to see interest paid out before tax on the easy-access Direct Saver worth 1.1 per cent, which is available online or over the phone.

Direct Isa at 1.5 per cent, Children’s Bonds at 2.5 per cent fixed for five years along with Premium Bonds will continue to be tax-free. This will also be the case for returns on fixed-rate and index-linked certificates, which are no longer on sale to new savers.