In this section:
What is a fixed rate ISA?
A fixed rate ISA (Individual Savings Account) is a type of cash ISA that provides a guaranteed rate of interest for the term of the account. With a fixed rate ISA your money is typically locked away for a set term.
Breaking it down further, a cash ISA is an account where the interest you earn on your savings is not taxed. The fixed rate version of this type of account comes with a choice of term lengths from one to five years. Your interest rate will be fixed until maturity. However, you won’t be able to access your money during this time without incurring a hefty penalty charge or risking closure of the account.
Each of us has an individual ISA allowance of £20,000 per year (tax year 2020-21). This means that you can deposit up to £20,000 into your fixed rate ISA during each tax year. Or you could deposit some of your annual allowance into a fixed rate ISA, some into a stocks and shares ISA and some into an innovative finance ISA. The key thing to remember is that you are only able to pay into one cash ISA each year, so you will not be able to open a fixed rate cash ISA and an easy access cash ISA during the same tax year.
What are the benefits of a fixed rate ISA?
A lot of benefits of a fixed rate ISA revolve around its tax-free status and its interest rate. But to access these benefits, you’ll need to be sure that you can afford to lock your money away for the full fixed term.
Here are the key benefits to having a fixed rate ISA:
1. You receive a guaranteed rate of interest with a fixed rate ISA. So you can easily calculate what your savings pot will be at the end of the term. Unlike an easy access ISA, which has a variable rate of interest, the interest rate of a fixed rate ISA cannot change.
2. You are likely to receive a higher rate of interest with a fixed rate ISA. Banks and building societies tend to offer higher interest rates if they know that your money will be invested with them for the duration of the term. So in a low interest rate environment, this may be one of the few opportunities to get yourself a competitive savings rate.
3. You receive all the benefits of having a cash ISA with a fixed rate ISA. While the introduction of the personal savings allowance means that ISAs are less relevant than they once were, the benefits of an ISA are largely cumulative. With the ability to transfer from one ISA to another, you are able to shelter ever-larger sums from tax year after year. Just be aware that not all fixed rate ISAs allow transfers in. So check the terms and conditions before applying.
4. If you are an additional rate taxpayer, you don’t qualify for a personal savings allowance. Depositing your money into a fixed rate cash ISA therefore means you can shield your interest earnings from tax, while also achieving a guaranteed rate of interest.
How does a fixed rate ISA work?
With a fixed rate ISA you will need to pick the length of term of the account, typically one to five years. So you will need to think about how long you can afford to lock your money away for.
Once you have selected your fixed rate ISA, you will be able to make a lump sum deposit. This type of cash ISA doesn’t typically allow additional deposits during the term of the account. So if you prefer to make regular contributions to your savings, an easy access cash ISA may suit your needs better.
While your money is invested in the account, you will receive a guaranteed rate of interest. This is typically calculated daily and paid annually or when the ISA matures.
With a fixed rate ISA, you will most likely not be able to access your money during the length of the term. If you do, you will be penalised either in the form of lost interest or a flat penalty fee. For some fixed rate ISAs, accessing your money may result in account closure.
Once your fixed rate ISA matures, you will most likely want to transfer the funds into another cash ISA. Just be warned that some providers may automatically roll your savings into another of their fixed rate ISAs. But this may not necessarily be the right ISA for your needs or the most competitive offer available. Your existing ISA provider should contact you before your account matures. When they do this, maybe consider comparing the full range of fixed rate ISAs available to find the best deal. If you do decide to move your money, then check if your new ISA provider accepts transfers. If they do, then this will need to be done via an electronic transfer. If you just withdraw your funds from your fixed rate ISA, you will not be able to reinvest that part of your tax-free allowance again in the same tax year.
Can you add money to a fixed rate ISA?
With most fixed rate ISAs you are only able to deposit money when you open the account. Typically, you will find that you are unable to add money to a fixed rate ISA during the length of the term.
There are a few fixed rate ISAs that will allow further contributions for a limited period or while the ISA remains available to open. But with most, you will only be able to deposit a lump sum at the beginning.
This type of cash ISA is therefore ideal if you have a large amount of money that you are happy to lock away for a period of time. It means that you can achieve a guaranteed rate of interest and enjoy tax-free savings.
If it is likely that you will want to regularly add to your savings account or that you will need to access your money before the ISA matures, an easy access cash ISA will probably suit your needs better.
Can you transfer a fixed rate ISA before maturity?
The main limitation of a fixed rate cash ISA is that in most cases you will need to wait until the account matures before accessing your cash. You are technically able to transfer a cash ISA at any time during the tax year, but with a fixed rate ISA you will be penalised for doing so.
If you withdraw or transfer money from your fixed rate ISA before it reaches maturity, you stand to lose as much as 365 days’ worth of interest. Alternatively, you could be charged a flat penalty fee or be faced with account closure, which could erase all the benefits of investing in a fixed rate cash ISA in the first place.
This is why it is important to calculate how much you can afford to lock away, because if you try to access the money in your fixed rate ISA before maturity, you could find yourself worse off financially.
Are my savings protected in a fixed rate ISA?
As a fixed rate cash ISA is a savings account, it is protected by the Financial Services Compensation Scheme (FSCS). Being covered by the FSCS means that savings up to £85,000 are protected if the financial institution providing the ISA fails.
It is important to note that this is £85,000 per financial institution. So you could have multiple fixed rate ISAs with different banks, and as long as you do not exceed the £85,000 threshold with any one bank, your money will be protected.
The Motley Fool receives compensation from some advertisers who provide products and services that may be covered by our editorial team. It’s one way we make money. But know that our editorial integrity and transparency matters most and our ratings aren’t influenced by compensation. The statements above are The Motley Fool’s alone and have not been provided or endorsed by bank advertisers. The Motley Fool has recommended shares in Lloyds, Tesco and Barclays.