A cash ISA operates in exactly the same way as if you were putting money into a savings account that pays interest (the difference being. with an ISA, you don’t pay tax on the interest).
The limit for contributions to a cash ISA is £15,240 for the 2016/17 tax year, which runs from 6 April 2016 to 5 April 2017. The limit will rise to £20,000 in 2017/18.
Some cash ISAs can be opened with as little as £1, but others require more substantial amounts and are primarily designed to attract people who already have a number of years’ worth of cash ISAs and who are looking for a better rate.
Beware the teaser rates
Obviously, when you first open a cash ISA, you’ll look for one that has a competitive interest rate. As with ordinary savings accounts, many offer bonus rates to attract new business that typically only last for 6 or 12 months. You can also get variable rates as well as ones that are fixed for a year or even longer.
ISA rates tend to be more seasonal than mainstream savings account, however. Sometimes you’ll find that the rates on offer don’t compare that well with ordinary savings accounts, as the banks and building societies save their best offers for the March/April/May period, which is when most money tends to be put into cash ISAs.
Play the transfer market
As time passes, you’re likely to find that the rate you get on your cash ISA doesn’t compare very well with the products being offered to new customers. So it’s important to vote with your feet and move your money to another ISA provider if the gap gets too large. Make sure you don’t close your original account when you do this though, as you’ll lose the tax protection for the money held in your cash ISA.
It’s worth bearing in mind that the transfer of cash ISAs can take quite a while to be completed, particularly if there is a lot of demand for the ISA you’re transferring to. So it pays to be persistent and follow up your application if needs be.
The new Personal Savings Allowance
In the 2015 Budget, it was announced that a Personal Savings Allowance would be introduced in April 2016. This will mean the first £1,000 of interest will be exempt from tax if you are a basic-rate taxpayer, dropping down to £500 if you are higher-rate taxpayer (additional rate taxpayers receive no exemption).
As a result of this change, savings income will be paid gross by default, rather than the current system where 20% is automatically deducted. This is because the government reckons 95% of people will no longer need to pay tax on their savings.
Arguably, this change could make Cash ISAs less attractive, given that the vast majority of people won’t have to pay tax on their savings, although that may not always be the case should interest rates return to more normal levels. Nevertheless, it will be interesting to see what happens to demand for Cash ISAs when this new allowance comes into effect.
Free investing reports
The Motley Fool can help you invest better. We have several investing reports which are free to access and packed full of useful information on investing strategies and share ideas.