Where should I put my savings?
October 22, 2008 3:08 PM   Subscribe

Should my savings be in a tax-free ISA or in a normal savings account with higher balance and higher interest? (I'm terrible at accounting maths.)

In the UK we have tax-free savings accounts, called ISAs, into which you can deposit maximum £3600 per year. I have one of those with about £5000 in it, earning 3.5% interest.

I also have a normal (taxed) savings account, earning 4.5% interest, with about £30,000 in it.

My question is: Should I
a) gradually (£3600 per year) move the money from the normal savings account to the tax-free ISA, or
b) move everything from the ISA into the normal savings account, since the higher balance and higher interest will more than compensate for the taxation

I suspect (b), which makes me wonder what's the point of ISAs.

(Unrelated to the question, I realise those aren't the best interest rates on the market currently. As is always the case, they were, a few years ago when I opened the accounts. I should probably move banks again. But my essential question remains.)

(Also unrelated, I realise these are low-yielding, boring investments as I am a risk-averse investor, and there may be better things I could do with my savings.)
posted by snarfois to Work & Money (10 answers total)
Your ISA has a shockingly poor interest rate. Even a direct ISA from NS&I will give you 4.8% tax free. ISAs should outperform savings accounts if you're a tax payer - the only limit being the amount you can put in each year.

First, switch to a better ISA and gradually move the full limit each year to the ISA. Also get a better savings account and move the balance of the £30k to it. 4.5% is poor as well, if that's your gross rate (before tax). Birmingham Midshires are offering something like 6.4% on their internet savings account right now.
posted by wackybrit at 3:35 PM on October 22, 2008

Just to add, I've done some looking around and Natwest has a cash ISA account that gives you a 2% bonus (for 12 months) when switching from another provider. This will give you (at your balance) an AER of 6.67% (or 6.51% gross).
posted by wackybrit at 3:39 PM on October 22, 2008

If it helps, and if your laws are like the US's, think of interest in your taxable account as being taxed at the highest tax bracket your income is in.

Here in the states, that's often 25%, or 28% for upper middle class wage earners.

So a 4.5% account is really earning 4.5% x (1 - .25) = 3.375% for a 25% marginal rate taxpayer.
posted by troy at 4:08 PM on October 22, 2008

Response by poster: The ISA is from Smile and the savings account is FirstDirect. Both were at least 6% when I opened them but have been creeping steadily downwards ever since. This seems to be the case for any savings accounts I've ever used (and I have switched banks many times).

The main question for me is the large difference in balance between the 2 accounts. Even with higher taxation, aren't I earning more every month in the normal savings account? Bear in mind I can't move the entire balance over to the ISA, only £3600/year.
posted by snarfois at 4:21 PM on October 22, 2008

You *can* move the entire balance of your old ISA over to a new ISA - I'm doing exactly that, moving my Smile ISA to Natwest. See moneysavingexpert.com for more details.

I've got to get round to calling Natwest and asking them what to do. Don't just walk into the bank with the Cash ISA transfer form - apparently that doesn't work...

Then put the rest into a savings account - You can get 6.3% interest (or 4.7% interest after tax) - although given interest rates are going to drop, that figure will also drop.

So you might also want to look at fixed-rate savings account, which will give you up to 7.2% interest before tax - or 5.4% after tax (or thereabouts).

But yeah, definitely feed as much as you can into an ISA account.
posted by almostwitty at 4:30 PM on October 22, 2008

Even with higher taxation, aren't I earning more every month in the normal savings account?

Depends. If you earn under about £40k p.a. that 4.5% drops to 3.6% which is still higher than 3.5%. But if you're a higher band taxpayer, it'd only be 2.7% so the ISA would still win. These points are moot though. If you're trying to get the best return, you'd find both a better ISA and a better savings account anyway.
posted by wackybrit at 5:21 PM on October 22, 2008

Response by poster: But it's not just about interest rates, though: it's about the balance that the interest is calculated on. 3% (after tax) interest on 30,000 still earns me more every month that 4% (untaxed) interest on 5,000, doesn't it? So shouldn't I keep the balance as high as possible by pooling all savings there?

Or am I making some kind of logical error? Would the the ISA gradually overtake the other account, and in the long run earn me more in interest than if I had pooled all savings in the taxed savings account?
posted by snarfois at 2:17 AM on October 23, 2008

Yes, you are making a logical error. The question is really about the incremental benefit of adding 5k to your 30k, not the total benefit of 35k. i.e. how much more does 35k earn compared to 30k? The answer is that the incremental benefit (the extra amount you would earn) is smaller than you could achieve by tranferring your 5k to a good ISA.

Also, seconding almostwitty - I transferred a cash ISA recently, without any bother. Just identify the ISA you want to open and contact the provider. They will tell you how to go about it, probably by sending off a simple form. And you could also do better with your 30k, just look around as suggested above.
posted by Jakey at 2:54 AM on October 23, 2008

Moneysavingexpert covers this well, although it doesn't cover previously mentioned fixed rate accounts.

So, gradually move your money into the best paying isa, and keep the rest in the best paying savings acccount you can find. And if you can cope with the hassle, set up the regular savings accounts and pay the maximum amount into them, as this will maximise your interest.
posted by timmow at 4:08 AM on October 23, 2008

Just a quick mention on the falling rates you mention - from my experience, banks will advertise a great rate for an ISA or a savings account, but what they don't advertise (which is mentioned in the small print) is that the rate expires after a certain date (in my experience, one year).

So I opened an ISA a few years ago with my bank at 6.5% but as soon as 6th April rolled around, the interest rate dropped to something ridiculously low. Same with my Regular Savers account. I get a really high rate for auto-deposits into the account every month (up to £250) for one year (interest paid at the end), but when the one year anniversary passes, I can't make any more deposits and my money pool sits there earning like 1.5%. You can transfer your cash ISA into an ISA somewhere else at any time. This doesn't count as a 'new' contribution (so you can still use your £3600 for the year) and you don't lose the tax wrapper. But make sure that you are clear on any possible transfer fees and make sure you ask how long that interest rate will last. Then remember to transfer it at the end of the period. You may also be able to speak to your bank and get the cash rolled over into a new, higher-interest account. But you should defo shop around to find a good rate. If you check moneysupermarket.com, you'll find there are some scandalous rates out there right now. I know that a few weeks ago, the AA had an account offering something like 7.2%!
posted by triggerfinger at 12:20 PM on October 23, 2008

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