Savings allowance: Is it time to dump Isas?

From yesterday all your savings accounts will stop having tax deducted from interest payments. It doesn’t matter if they are Isas or normal accounts, you will no longer automatically pay income tax on your interest.

This is thanks to the arrival of the new savings allowance. This allows basic rate taxpayers to earn up to £1,000 interest on their savings each year before they have to pay income tax on that money. Higher rate taxpayers can earn up to £500, but additional rate taxpayers earning more than £150,000 will still have to pay income tax on savings interest.

So, if you don’t have to pay tax on your savings interest now, why bother with Isas? For some people Isas may no longer be worthwhile, but don't assume you are one of those people.

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Big savers

If you have a large amount of savings you should still make the most of your Isa allowance. A basic-rate taxpayer with savings of £34,000 earning three per cent interest would earn more than £1,000 interest in a year. A higher-rate taxpayer with £17,000 in savings would need to pay tax if they were earning the same level of interest.

If you have large amounts in the bank and you opt for a standard savings account you will have to keep a careful eye on how much interest you are earning. If it goes over the £1,000 or £500 threshold you will have to fill out a self-assessment form in order to pay the tax you owe, which obviously adds hassle.

In contrast if you put £15,240 into an Isa it can grow freely without you ever having to worry about tax bills.

Rising earners

Anyone who’s earning potential is on the up needs to think carefully before abandoning Isas. If you get a pay rise that pushes you into a higher income tax bracket your savings allowance will be slashed in half, or disappear completely if you become an additional rate taxpayer.

If your earnings are close to the next tax bracket it could be worth using Isas in order to avoid a pay rise having a sting in its tail.

Building a nest egg

If you only have a small amount of savings and are looking to start building a nest egg, you may not want to bother with Isas at the moment. The interest rates offered on standard accounts are far, far better.

For example, the best instant-access Isa rate currently available is a paltry 1.4 per cent from The Coventry. In contrast, you could get three per cent interest on the Santander 123 current account if you have more than £3,000 to deposit, or you could get up to six per cent with a regular savings account from First Direct or Marks and Spencer Bank.

The only time nest-egg builders should consider an ISA is if you are saving for your first home, then use a Help to Buy ISA so you can benefit from a 25 per cent top up to your savings from the government.

Isas may not offer the best interest rates but they offer piece of mind and low-effort tax-efficient saving so should continue to form a part of many people’s savings portfolios.