Cash ISAs may have delivered better returns than ordinary savings accounts for many higher rate taxpayers since 2020, despite standard accounts offering higher interest rates, according to new analysis.
The findings, from Moneyfacts, highlight how ISAs’ tax advantages can outweigh headline interest rates, especially as frozen thresholds push more people into higher tax bands.
With rumours circulating that the Treasury could reform or cap cash ISA limits in next month’s Budget, the data shows that people with large savings could have benefitted from putting their money in the best cash ISA accounts.
Here, we explain how ISAs have compared to regular savings – and why the debate over reform matters.
ISAs pull ahead for larger and higher-rate savers
Higher rate taxpayers – who pay a 40 per cent income tax rate – benefited significantly from the tax shelter ISAs provide, particularly on larger sums.
Someone with £13,500 in savings would have avoided £282 in tax over six years but still been £7 better off with a standard savings account.
However, a saver with £50,000 would have avoided £3,207 in tax and ended up £2,315 better off with an ISA compared with a top savings account.
The analysis is based on a comparison of the best one-year fixed cash ISA and the best one-year fixed account available in each October from 2020 to 2025, taking into account compounding interest and tax obligations.
For basic rate taxpayers, the picture was more mixed. Those with typical or medium-sized savings of £13,500 to £20,000 did not exceed their personal savings allowance (PSA) – how much interest you can earn from savings without paying tax – meaning ISAs offered no real tax advantage.
In these cases, savers would have been better off sticking with a regular savings account – £393 better off on £13,500 and £478 ahead on £20,000, for example.
But once savings reach £50,000, even basic rate taxpayers begin to breach the PSA. While they would save around £1,200 in tax by using an ISA, they would still be £59 worse off overall due to the higher rates offered by standard accounts.
A basic rate taxpayer earns up to £50,270 a year and can earn up to £1,000 in savings interest tax-free under the PSA.
Those on higher incomes – between £50,271 and £125,140 – are higher rate taxpayers, paying 40 per cent income tax and getting a smaller £500 PSA.
Anyone earning over £125,140 falls into the additional rate band, paying 45 per cent tax and receiving no tax-free allowance on their savings interest.
More savers to fall into higher tax bands
The Office for Budget Responsibility projects that by 2028-29, an additional 3.5 million people will move into the higher rate tax band, and 600,000 more will fall into the additional rate band of 45 per cent.
With income thresholds frozen, more savers will find themselves paying tax on their interest, potentially increasing the value of ISAs.
Adam French, head of news at Moneyfacts, said ISAs were once seen as outdated, but recent rate rises have made them relevant again.
For much of the 2010s, ISAs were underappreciated because of rock bottom rates, and the introduction of the PSA made their tax advantages feel “irrelevant”.
He explained: “But, with interest rates now back at more sustainable levels, ISAs have regained their purpose.
“When rates were languishing around 1 per cent, most savers didn’t earn enough in interest for tax to be an issue, but now due to the combination of frozen tax brackets and greater returns, many do.
“Higher rate taxpayers in particular stand to lose 40p in every £1 of interest earned beyond their £500 PSA.”
The Bank of England’s base rate is currently 4 per cent, having been held at this level since the Monetary Policy Committee decision in August. The next scheduled announcement for the base rate is on November 6.
Treasury eyeing ISA limits
French, of Moneyfacts, warned that the Treasury has noticed how the cost of tax-free savings has risen alongside stronger returns.
Rumours of slashing the deposit limit have been regularly circulating, reportedly with the aim of getting more savers to shift their money into investments.
But in the short-term at least, reducing the amount that can be sheltered in a cash ISA is more likely to push savers into taxable savings accounts, boosting revenues for the Treasury instead, he said.
He added: “Whether it’s worries about inflation, stagnant wages or global instability, we are more likely to save for a rainy day than take risks with our cash.
“Financial security and building an emergency fund are two of the biggest reasons Brits have told us they put money away, and the reality is that millions of savers rely on the simple and secure nature of cash ISAs with their guaranteed tax-free returns to do this.
“Weakening this option may erode savers’ sense of financial security which risks undermining any appetite for investing excess cash.”
Ultimately, he said, fostering an investment culture in the UK needs a cultural shift in attitudes towards saving and building wealth built on the back of a broader feeling of financial security.
David Beaston, technical manager at The Investing and Saving Alliance (Tisa), echoed those concerns.
He said: “Despite the Government’s laudable objective of wanting UK savers to move towards more equity-based investing which could result in superior returns over the medium and longer term, it is Tisa’s strong belief that simply reducing the cash ISA limit will not achieve this.
“We believe this to be a flawed logic which will simply result in more funds being deposited in taxable deposit accounts and not in stocks and shares ISAs.”
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