The trick that can turn your cash Isa into a flexible tax-free winner
What’s the best thing to look for in a cash Isa?
A good savings rate is the obvious answer, but there is also a lesser-known element that you may be overlooking that could prove very useful in keeping your savings tax-free as much as possible.
It’s something all Isas could offer but not many do, and it’s even more important that rising interest rates are now causing more people to lose interest in interest income tax on standard accounts.
The feature you should be asking about is whether an Isa is flexible.
Flexible friend: An Isa feature that has flown under the radar since launch can make your tax-free pot much more useful
With a flexible Isa, you can withdraw and deposit money without it counting as part of your Isa, as long as you replace it in the same tax year.
It turns your ISA from something you try not to withdraw cash from – for fear of losing valuable tax-free protection – into a savings pot you can dip into when needed.
Flexibility is also a feature you can get with a stocks and shares Isa, but it is more useful for easy access to cash savings than investment pots.
The feature was launched in April 2016 by former chancellor George Osborne – a man who enjoyed a bit of Isa tinkering – but has flown somewhat under the radar since then.
I think that needs to change, especially now that higher tax rates and a freeze on income tax limits mean more of our hard-won savings interest is being raided by the taxman.
A flexible Isa is most beneficial for those with large cash holdings and the financial strength to fill their Isa each year, but it is also valuable in terms of changing financial behavior for those who cannot.
Because although most of us have little hope of using up our entire £20,000 ISA balance each year, we still tend to put any money or cash we might need into standard easy access savings accounts for a rainy day .
When interest rates were low this didn’t matter as much as the personal savings allowance protected many from tax on their interest, although the £1,000 allowance is halved for higher rate taxpayers and removed for additional rate taxpayers.
But now that the best easy-to-access savings accounts pay 5 per cent or more, a basic rate taxpayer who has saved more than £20,000 would start losing interest to tax.
Meanwhile, a higher rate taxpayer would have to pay tax on a savings pot of more than £10,000.
We have regularly urged readers to put their money into Isas and not rely solely on the personal savings allowance, even when interest rates have been low for that very reason.
The savings tax has a disincentive effect on the effective tax rate you receive. It turns the best accessible savings rate of 5.2 per cent paid by Coventry Building Society into 4.16 per cent for basic rate taxpayers and just 3.12 per cent for higher rate taxpayers.
Put your money into Coventry BS’s cash Isa instead and you’ll get 4.9 per cent without having to worry about taxes.
So why don’t we all put as much money as possible into flexible Isas?
Unfortunately, it’s because Isa flexibility hasn’t caught on nearly as well as it could have.
Many banks and building societies don’t offer it – and even some that do, the benefit is somewhat negated by the limit on withdrawals per year before your interest rate drops.
Additionally, to get the most benefit from this, you should also be able to transfer old Isas into the pot, meaning the choice is narrowed down even further.
A look at the top deals in our cash Isa tables shows how difficult it can be to find a cash Isa that gets all of this right.
For example, the Coventry BS Isa mentioned above is flexible but limits withdrawals to four per year, otherwise the rate drops. This is also the case with Virgin Money, which limits withdrawals to three.
Moneybox’s 5 per cent paying cash Isa is not flexible and has withdrawal limits, while Shawbrook, Charter Savings Bank, Oaknorth and Cynergy all compete at the top of the table and have no withdrawal limits but their Isas are not flexible.
Of the eight best cash Isas in our tables, Skipton’s Bonus Cash Isa is the only one that I think is flexible, has no withdrawal limits and accepts transfers and pays out a whopping 4.9 per cent.
The catch is that 1 percent of that rate is a bonus that expires after one year. At this point you’ll either have to hope that Skipton offers another top offering with all these features, or start looking for that flexible Isa needle in a haystack again.
In the meantime, let’s hope more banks and building societies offer flexible ISAs and offers that don’t restrict withdrawals.
It would certainly help them stand out from the crowd – and we’ll be highlighting those who have flexibility in our tables shortly.