Savers who shunned cash ISAs to chase the best rates could now be left with unwanted tax bills that wipe out the extra interest earned, calculations by investment platform AJ Bell show.
The figures illustrate savers using non-ISA accounts – which tend to pay slightly higher interest than ISAs – over the past five years could see the benefits erased if they breach the personal savings allowance and have to hand money to the taxman.
A recent FOI request from AJ Bell shows that almost 2.75 million taxpayers are expected to pay tax on savings interest this year. Many opted not to use cash ISAs to shelter interest from the taxman when hitting the £1,000 personal savings allowance looked a remote possibility thanks to much lower rates of interest.
AJ Bell’s calculations show an individual who saved £10,000 a year for the past five years will have earned an extra £255 by chasing the best rates, opting for non-ISA accounts and switching regularly to get the best terms. However, now interest rates have risen and their savings have grown they will breach the Personal Savings Allowance and face paying tax on their savings interest.
That same individual will pay £247 this year in tax on their savings if they’re a basic rate taxpayer. It means this year’s tax bill almost entirely wipes out the benefit of saving outside ISAs over the past five years.
A higher-rate taxpayer who saved that same £10,000 a year over the past five years faces paying £694 in tax this year, while an additional rate taxpayer will be paying £1,006 in tax – almost four times more than the additional gain they saw from using a non-ISA account.
The higher the savings the larger the tax hit – on £20,000 of annual savings in each of the past five years the benefit of using a non-ISA accounts is £510 – but the tax bill on those savings today is £694 for a basic-rate taxpayer, £1,589 for a higher-rate payer and £2,012 for an additional-rate payer.
While those with modest savings pots can mitigate the problem by using this year’s ISA allowance, those with a bigger savings balance won’t be able to shelter it all from the taxman. Lots of savers will have pots worth more than the £20,000 annual ISA limit, meaning it will take years to shelter the whole pot from tax. In the case of someone who has saved £10,000 a year, even if they moved £20,000 of their cash savings into an ISA this year, higher and additional-rate taxpayers would still face a bigger tax bill than the premium they gained from non-ISA saving.
Laura Suter, head of personal finance at AJ Bell, comments:
“The number of people using an ISA dropped dramatically after the Personal Savings Allowance launched in 2016, as it meant the majority of people wouldn’t pay tax on their savings. On top of that, savers chased the higher returns on offer from non-ISA accounts. That logic worked fine while interest rates were low, but now a combination of higher interest rates and more people being pushed into the next tax bracket thanks to frozen allowances means vastly more people are paying tax on their savings.
“Those with considerable cash stashes can’t just shovel it into an ISA, as the £20,000 annual limit means it will take multiple years to move their entire cash savings into the tax-free accounts. In the meantime they will be handed tax bills for the interest on their savings. These figures lay bare just how short-termist the move to shun ISAs was. The additional interest generated over the past five years has been wiped out in a single year for most people by the higher tax bills they are now facing.
“The mantra until now has been that you only need to use an ISA if you’ll pay tax on your savings, but that’s not the case. You should consider both your current situation and your future one: you need to think about whether you are ever likely to pay tax on your savings. For those with smaller savings pots it’s less of an issue, partly because you’re less likely to breach your Personal Savings Allowance and partly because you can move all your savings into an ISA in one tax year.
“But anyone building up wealth over time runs the risk of paying tax on their savings and not being able to quickly move it all into an ISA. Even for moderately wealthy people who have decent savings pots, or who are likely to be pushed into the next income tax bracket and lose some or all of their personal savings allowance, an ISA today will keep the taxman away tomorrow.
“Fortunately for savers the difference between the top cash ISA rate and the top non-ISA account isn’t vast. Currently, according to Moneyfacts, the top ISA easy-access account pays 4.43% compared to the top non-ISA equivalent of 4.81%. On £10,000 of savings that only equates to an extra £38 a year.
“This is a cautionary tale that ISAs aren’t just for times of high interest rates or when you’ve hit the tax-free Personal Savings Allowance limit, it’s a good idea to consider them far before you’re hit with a tax on your savings to ensure you protect your money from the taxman’s clutches in the future.”
