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Cash does better outside ISA

October 7th 2009

However, the way to secure the best interest rates on savings at the moment, with Bank Base Rate still at 0.5 per cent and providers anticipating rate rises, is via fixed rates and here the ISA advantage falls away. With fixed rate cash ISAs offering lower rates than similar term fixed rate bonds, investors have a dilemma, should you go for a better fixed rate on a taxable account, or is it better to secure long-term tax efficiency? Consider comparative rates illustrated on the table below.
 
Bank/Building society
Fixed-rate
cash Isa
Fixed-rate
bond
Difference
Britannia
2.60% for £3,600
until 30/06/2010
3.50% for £1,000
for 1 year
0.90%
Derbyshire BS
3.00% for £100
until 31/08/2011
4.15% for £100
until 31/08/2011
1.15%
Dunfermline BS
2.80% for £100
until 31/08/2010
3.75% for £100
until 31/08/2010
0.95%
Dunfermline BS
3.00% for £100
until 30/11/2011
4.15% for £100
until 31/08/2011
1.15%
Julian Hodge Bank
3.50% for £3,600 for
5 years
4.40% for £1,000
for 5 years
0.90%
National Counties BS
3.00% for £1,000 for
3 years
4.31% for £20,000
for 3 years
1.31%
Source: Defaqto, 07 August 2009
 
Independent financial data collection and research company, Defaqto, says: "It has been apparent for some time that the interest rates paid on fixed rate cash ISAs have lagged behind what's available in the fixed rate bond market and this is very disappointing for savers. Cash ISAs clearly provide significant benefit to taxpayers but the low rates on offer are negating a lot of the potential advantage. There is no reason why providers can't offer the same fixed interest rate for both bonds and ISAs if they're for the same term. However, it would appear that there is not the same level of competition for fixed rate cash ISAs as there is for fixed rate bonds.
 
It would seem that as the majority of people take out ISAs at the end or the beginning of the tax year, it will not be then until the market sees more competition in ISA rates.
 
The choice now
So should you forgo a cash ISA for a fixed rate bond or move your existing cash ISAs into ordinary savings accounts? The problem is that the annual ISA allowance is a case of "use it or lose it". Once the tax year is gone, you can't retrospectively pay that year's £3,600 allowance into an ISA. So you should still take a cash ISA out each year to gain the full benefit when interest rates rise, or when cash ISA rates once again become competitive, or when you become a higher-rate taxpayer.
 
Cash ISAs still make sense for higher-rate taxpayers, who would have to secure 5.83% on a fixed-rate bond to beat 3.5% on a one year fixed-rate cash ISA.
 
Also bear in mind when making your decision that:
 
■ Some ISA providers will not accept transfers in from other providers.
■ You can move your cash ISA into equity ISAs at a later date if your appetite for risk changes
■ Savings built up via ISAs can be invaluable in retirement for their ability to generate a tax-free income.
 
According to Defaqto, those providers with the largest differences between rates offered on cash ISAs and fixed rate bonds are Britannia, Derbyshire BS, Dunfermline BS, Julian Hodge Bank and National Counties BS.
Other providers offering higher rates for similar term fixed rate bonds than for their fixed rate Cash Isa counterparts include: Alliance & Leicester, Bank of Cyprus, Buckinghamshire BS, Chelsea BS, Cumberland BS, Halifax, Norwich and Peterborough BS, Saga, Wesleyan Savings Bank.
 
The recent change in regulation means that the investor can now transfer the accumulated value of existing cash ISAs to a Stocks & Shares ISA. Individual circumstances will dictate as to whether such a transfer would be beneficial, and this is where independent investment advice is essential.

Recent falls in interest rates have potentially made a Stocks & Shares ISA a particularly attractive proposition, in that a range of investments can be included to provide a tax efficient income, far in excess of that available from cash. Such investment will of course depend upon the individual’s investment objectives and attitude to risk. An example of what to invest in would be to purchase a fixed rate gilt stock (UK Government bond) within the tax wrapper of the Stocks & Shares ISA Plan. Most Investment Managers will
offer this facility

The caveat to this is that gilts are quoted on the London Stock Exchange and the capital value does fluctuate on a daily basis (although as an asset class it is generally regarded as a safer asset class than holding equities).

A tax free income yield of about 4.5% is currently available from the longer-dated gilts where the Gross Redemption Yield is of a similar value (this is because the market price is trading at or around par). As always “Caveat Emptor” take independent financial advice before you invest.
 
If you require advice on your current investment or for other investment advice please give us a call on 0113 287 8200 or e-mail us on advice@prosperis.co.uk