Martin Lewis: Got a cash ISA? Millions should ditch them but many others should get them – it's all about tax

Watch Martin's full explanation below. Plus, see our Personal savings allowance guide for more info on how tax on savings interest works, and our Top savings accounts guide for the current top payers. If you already pay tax on savings interest, or you're near the limit when you'll do so, here are our Top cash ISA picks.

ITV's The Martin Lewis Money Show Live – Tuesday 1 November 2022

The clip above has been taken from The Martin Lewis Money Show on Tuesday 1 November 2022, with the permission of ITV Studios. All rights reserved. Watch the full episode on the ITV Hub.

Here's a full transcript of Martin's cash ISA action plan

Martin said: "This is all about tax. And it's all about the personal savings allowance, which was introduced in 2016. What that says is, if you are a basic 20% rate taxpayer, you can earn £1,000 a year of interest in any savings account – any UK savings account, any form of interest each year – and you do not pay tax on it. So, to earn £1,000 worth of interest, you actually need a decent whack of savings.

"Let me do the numbers for you. You would need £40,000 in the top easy-access account before you started earning £1,000 of savings [interest]. You'd [need] £20,600 in the top two-year fixed account. If you're a higher 40% rate taxpayer, you get £500 a year. If you're a top 45% rate taxpayer (that's earning over £150,000 a year), you don't get any. So at £500 a year, you just halve those numbers: £20,000 in easy-access, £10,300 in a fix.

"But what's really interesting here is how this has changed. If we go back in time to April 2021, in the top easy-access account, as a basic rate taxpayer, you'd need nearly £250,000 before you pay tax. So very few people paid tax. But as rates have started to increase, the amount you need in savings has decreased. So far more people now will be paying tax on savings.

"Let me just ask my audience – how many of you have cash ISAs? Hands up. OK, so quite a decent number. I'm going to ask you again, whether you still need them, at the end. So what I want you all to do is work out now, on a rough estimate, do you think you will pay tax on savings interest? Because that's crucial for where we go next."

Cash ISAs: should you use them or lose them?

"A cash ISA is just a savings account where the interest is never taxed. And that interest doesn't count towards your personal savings allowance – it doesn't count towards that £1,000; it's a totally separate allocation.

"You can put up to £20,000 per tax year in it (the tax year ends on 5 April). And then, once it's in, it's tax-free year after year. So you could put £20,000 in this tax year, and another £20,000 in next tax year, and another £20,000 in the tax year after – and that would be £60,000 that you would have in. So some people who've been doing ISAs for years can have £100,000s [in them].

"Now let's look at this, I'm actually going to start at the bottom here for how this works. The top cash ISA rate on a two-year fix is Saffron Building Society, 4.35% – but that doesn't accept transfers, so if you wanted to transfer one, it's 4.31% with Virgin Money. Nowhere near as high as the top normal savings fix at 4.85%. So if you don't pay tax on savings, you absolutely want the 4.85% because it's way higher than 4.35%.

"But if you are paying tax on those savings, look at the effect, it brings the rate down at basic tax to 3.9%, at higher tax to 2.9%, at top tax to 2.7% – way less than you get in a cash ISA. So for money that is being taxed, you'd be better off to fix in the cash ISA than you would in normal savings. Same is true of one-year fixes, where the top payer cash ISA is 3.9% with Secure Trust.

"Rarely – and this all changed today [Tuesday 1 November], it wasn't like this yesterday [Monday 31 October] – right now, the top-paying cash ISA from Marcus at 2.5% is the same as the top standard savings because they've launched the same rate on both. That doesn't happen often. So on easy-access today there's no difference; normally, standard savings pay more."

What you should do depends on whether you pay tax on savings interest

"Let's look at the action plan here... if you've not got a cash ISA but you pay tax on savings, then open up a cash ISA and put the amount of savings that's taxed in a cash ISA, whether it's a fix or easy-access.

"If you already have a cash ISA and you pay tax on some savings, well then make sure you're getting the best rates. You don't have to keep it where it is: you have a right to transfer it. So apply for the top ISA that you want (top cash ISA). And during that process, you'll be asked if you want to transfer money from your existing ISA, and just transfer it across, so you can increase those rates.

"Most cash ISAs are paying fractions of what I just listed. Never withdraw the cash to do this though – because then it's not a cash ISA any more, and you lose whatever allowance you've had from past years.

"If you already have a cash ISA and you are not going to pay tax on savings, well then, you get no benefit from it being in a cash ISA. I used to say: 'Money is always nicer in an ISA'. But that was before 2016. And I need to deprogramme you for that now. If you're not paying tax on savings, put your money in the highest interest account, whatever type of account it is."

Two reasons you may want to keep a cash ISA

"Two minor exceptions. If you're very close to the [personal savings] limit, because interest rates are going up you might want to use a cash ISA to protect some of it in case those interest rates go up and you're being caught by tax.

"Or if you wanted to fix but you needed the option of being able to withdraw, well, cash ISA fixes must allow you to withdraw money – although they can charge interest penalties of normally around 180 days' worth of interest. But it does give you the option.

"So back to who had the cash ISAs – hands up. Are any of you thinking you shouldn't have a cash ISA now as you're not going to be paying tax on it? So if you're going for a fix, you want to get out of that cash ISA and move it somewhere else. The rest of you, you need to be transferring it if you're not getting the top rate. And that's cash ISAs done."