Martin Lewis: Three important questions for anyone with a cash ISA
Don't pay tax on your savings interest? Then cash ISAs are probably not for you. If you do, and a cash ISA works, then make sure you check your rates as most earn diddly squat. That's the message from MoneySavingExpert.com founder Martin Lewis in the latest episode of ITV's The Martin Lewis Money Show Live.
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 24 January 2023
You can turn on subtitles by clicking the closed captions icon in the bottom right of the video. The clip above has been taken from The Martin Lewis Money Show on Tuesday 24 January 2023, 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 explainer
Angelica Bell (Martin's co-host) said: "Let's go to our studio audience. Wade is here."
Wade (audience member) said: "So basically I've got about £20,000 saved up and I'm thinking of putting it into a cash ISA. I won't be needing this money for a while - how do you know if it works for me?"
Martin Lewis said: "Look, I used to say before 2015, your money is nicer in a cash ISA, but you haven't heard me say it for a long time and some people need to be deprogrammed about cash ISAs. So I've got three questions for you, which will hopefully explain whether an ISA is right or wrong.
"Let's do question number one. Okay, so the first question: Is your money wrongly in a cash ISA? So the first thing to understand is normal savings will beat a cash ISA because normal savings pay a higher rate of interest. The benefit of a cash ISA is it's tax free. Since 2016, most people don't pay tax on their savings, because you get the personal savings allowance.
"Let me first explain [what the personal savings allowance is - also see the graphic below]. On any savings account at all, not an ISA, but on any normal savings, a basic rate taxpayer can earn £1,000 a year of interest - tax free. With higher rate taxpayers earning above £50,000, [you] can earn £500 a year tax free, and a top rate taxpayer (earning) around £150,000 can't earn anything tax-free; it's all taxed."
"So what does that translate to in actual amounts? Well, in the top easy-access account, which is currently at 2.9% [this has since increased to 2.92% at the time of writing], you'd need nearly £35,000 before any of your interest was taxed as a basic rate taxpayer, [you'd need] half of that as a high-rate taxpayer. And then in the top fixed-rate [at the time of filming], it'd be £22,000 at basic rate tax, and £11,000 at the higher rate tax.
"Now, as most people have less than £10,000 in savings, well, you don't pay tax. So therefore you want to put your money where the interest rate is highest - and that's normal savings.
"So if you've got a cash ISA and you're not paying tax on it, you may want to move it to where you can earn more money."
'If you've got a cash ISA and you're not paying tax on it, you may want to move it to where you can earn more money'
"Which takes me to my second question: If a cash ISA is right for you, can you earn more? And the answer, of course, for many, because you're earning diddly squat, is yes.
"So let's just explain it for those with larger savings who may pay tax on their savings interest. So, you're earning more than £1,000 a year as a basic rate taxpayer, in interest.
"Cash ISAs are simply savings accounts you don't pay tax on. You can put £20,000 in per tax year - so you put in £20,000 this tax year, and then the next tax year and the year after that - that's £60,000 in total [and] all of it would be tax free.
"The interest is never taxed on money in cash ISAs and it doesn't count towards the personal savings allowance so you can still have up to £1,000 in other things, no matter what you've got in a cash ISA - that's its benefit.
"Now, here we go, there's cash ISAs and there's standard savings [see the graphic below]. The top cash isa is 2.85% - easy access - which is actually not that bad a rate at the moment, but you'd earn more in Shawbrook Bank's normal savings."
"However, if you did pay tax on that element of savings, look, after basic rate tax it's nowhere near close to the top cash ISA of 2.33% - and it's worse if you pay more tax. And the same trend, look, the top one-year fixed cash ISA [is] 4% at Barclays but [it's] way more in the top standard savings at 4.33%.
"Though again, after basic or higher rate tax, you're better in the cash ISA. Same with a two year fix; 4.11% Virgin Money cash ISA, Atom Bank is 4.45%. So on the money [that] isn't being taxed anyway, you want to put it in the top standard savings, but if you're earning enough interest, just put them in the top standard savings.
"Unless you've got a lot of savings, or you're getting close to where you might start paying tax for some amounts, then you might want to [ditch your] cash ISA."
'If a cash ISA works for you, check your rates as most earn diddly squat'
"One very important thing is if you have got a cash ISA, and if it's right for you because you pay tax on savings, check your ISA rates now because most pay diddly squat. If it's pants, what you do is you open one of those new top cash ISAs, and all of those allowed transfers. In the application form, it will ask: 'do you want to transfer another cash ISA in?' You fill that in and you let the new provider transfer the money across for you.
"What you DO NOT do is just withdraw the cash, because then you lose the cash ISA status and if you were to put it back into cash ISA, you'd use up this year's allowance. So many people are earning way, way less than those rates in a cash ISA, In which case, do a transfer."
'If you've got a fixed rate ISA, most of you should ditch, switch and pay the penalty'
Angelica Bell (Martin's co-host) said: "A viewer is asking 'I have a fixed cash ISA that will mature in November 2025. The rate of interest I'm getting is 1.25%. Can I transfer it to another provider for a better fixed rate? Or am I stuck with the rate until 2025?"
Martin said: "You absolutely can, and you will make a lot of money. And when I do this next bit, I'll do the maths on that. So let me move onto my third question, which is really important.
"If you've got a fixed rate ISA, most of you should ditch, switch and pay the penalty. Here's how it works..."
"Fixed ISA rates have dropped recently, but unlike normal fixes, with cash ISAs they cannot lock your money away. They can charge you an interest penalty if you withdraw it early, but you are always allowed access to your money, which is why it can be an option for people who don't want to lock away.
"So, let me do some chalkboard maths that I prepared earlier. Imagine you save £10,000 in February 2021. Staggeringly, the top three-year cash ISA then paid just 0.7%. So now, you've got one year left on it, so let's just do the equation over one year.
"You switch it to the top one-year ISA fix at 4%; that would earn you £400 interest this year. You wouldn't get the 0.7% interest on the rest of the year in the cash ISA you were in, so you lose £70 on that.
"And there's a 270-day interest penalty, which sounds a lot, but 270 days when you're not earning very much, isn't very much - it's about £50.
"So you take the £120 off the £400 and it means the total gain from switching is £280. Now, there are free calculators online that will do this for you - you know, 'should I ditch my fix and pay a penalty on the cash ISA?'.
"So you do the numbers here: so she's [the viewer] gonna be going to around a 4.11% rate - if she had £10,000 in there with a typical 270-day penalty, until 2025 with a three-year fix is 4.11%, I think that's a gain of around £500, by paying the penalty and switching - which is roughly trebled the interest.
"For most people with fixed rate cash ISAs, I can't promise everyone, but certainly enough of you very close to the end of it should be ditching them, paying the penalty, and putting them [the money] in somewhere that pays more at the moment."