Are Cash ISAs still worth it? The battle against inflation explained
Investing your money in an individual savings account (ISA) is a popular way to earn tax-free interest on funds which you’re putting away for future use. There are several types of ISA, with the most common ones being cash and stocks and shares (S&S) accounts. A cash ISA is where you just deposit money to accrue interest over time, in comparison to a S&S ISA which involves depositing funds which are then invested. Whether you’re planning for retirement, emergencies, or just a nice holiday, these ISAs have been a valuable asset for investors for years.
Despite that, questions are now being raised over whether a cash ISA is still the best option for investment. Fluctuating interest rates and previously high rates of inflation have seen some turn to other options when it comes to their savings.
In this guide we’ll discuss why you might still want to invest in a cash ISA, what’s making other types of accounts more alluring, and what you could do to protect your savings.
What is a cash ISA?
A cash ISA is a savings account that offers tax-free interest. That means any interest you earn on money held within a cash ISA won’t be taxed – so long as you follow the rules of your chosen account.
There is, however, a limit on how much you can place in ISAs each tax year. Between April 2024 and April 2025 you can deposit this total of £20,000 into existing ISAs or new ISAs. This amount refreshes at the start of every tax year, but has been sat at £20,000 since 2017.
How does a cash ISA help you save?
Just as with most savings accounts, the aim of a cash ISA is to help you save while slowly building interest. So, what makes savings with this kind of account different?
If you save in a traditional savings account you could pay tax on the interest you earn. The Personal Savings Allowance protects the first £1,000 you earn through interest if you’re in the basic rate tax band, anything above this number contributes to your annual income. That means it gets taxed at the same rate as your regular wage.
In contrast, all money invested in a cash ISA can grow totally tax-free, even if you max out your limit for the year. For example, if you placed £20,000 into a cash ISA paying 5.5% interest, you would earn £1,100 tax-free.
For those in higher income tax brackets, a cash ISA is even more useful. Savers in the higher rate tax band only get an allowance of £500 a year, while anyone in the additional rate bracket gets nothing. Any money these individuals make from interest in an ISA is protected.
Why else might you choose a cash ISA?
Aside from the key benefit of paying no tax on the interest you earn, cash ISAs also have a number of other bonuses for those looking to invest in one. Here are a handful of other reasons why a cash ISA could make sense:
- You have set lifetime goals. If you know the money you’re saving is going to be used for a specific purpose, an ISA could be the answer. Lifetime cash ISAs are capped at £4,000 in additions across 12 months, but see a return of 25% (up to £1,000 per year) added on top of this investment by the government. The catch is that they can only be used for retirement or buying your first home. If you have one of these set lifetime goals in mind, the 25% rate top-up makes them a strong option. You also need to be aged 18 to 39 to open one.
- You want a low-risk investment. If you aren’t worried about how much you want to earn in investments, cash ISAs are a conservative choice. Where stocks and share investments might fluctuate up or down, a cash ISA will accrue interest at a steady rate. You have two options for the interest rate you choose:
- Fixed rate – where you’re locked into a set interest rate for a fixed period, usually between one and five years. During that time you can’t access your cash.
- Variable rate – where the interest rates fluctuates up and down but you can usually withdraw your money whenever you need it.
- You need instant access to your funds. Not all cash ISAs allow you to withdraw money throughout the course of the year. However, for those which do, the process is the same as transferring money from one bank account to another. This makes getting instant access to funds much easier than trying to withdraw it from stock and share investments.
- You want the ISA allowance to be inherited. While ISAs themselves can’t be handed over, since April of 2015 spouses of an individual who’s passed away can inherit allowance space. The ISA inheritance allowance is equivalent to the total balance of the deceased’s ISAs. That means if they had £150,000 saved into ISAs, their spouse would get an ISA allowance of £170,000 for the year. Spouses will still get their normal allowance, while also inheriting the allowance of the deceased.
This rule was introduced to make it easier for widows and widowers to protect money saved by their spouses, but also accounted for circumstances where they may not inherit the money in its entirety. - You value safety. All cash ISAs are protected by the Financial Services Compensation Scheme (FSCS) up to the first £85,000 saved, per financial firm – so long as the bank or building society offering the account is authorised by the FCA. As such, it can be smart to spread your savings across different firms to make sure each account is fully protected.
Are ISAs still worth investing in?
Despite this wide range of benefits, some are questioning whether cash ISAs are still the best option for your money. In periods of high inflation and low interest rates, it’s possible for money sitting in a cash ISA to accrue interest at a rate that is slower than inflation itself.
That can be a hard concept to wrap your head around, so think of it this way:
- If you invest £5,000 in a cash ISA with a fixed interest rate of 3%, you’d earn £150 across the year. This would give you a final total of £5,150.
- If the rate of inflation is 4% during this period (meaning you would need to turn that £5,000 into £5,200 to see the funds retain their value), your money is worth 1% less than it was at the beginning of the year, despite increasing.
In this scenario, a cash ISA wasn’t the perfect investment because the interest rate of 3% was lower than the 4% rate of inflation. The good news is that inflation in the UK is beginning to level out and drop again. As of the last report by Trading Economics, UK interest rates fell to just 2% in May of 2024.
With these figures in mind, anyone investing in an ISA with an interest rate of 2.1% or higher would see a positive benefit from doing so if they started today. This is a far cry from the beginning of 2024, when rates sat at 4% – and significantly lower than in June of 2023, when it was as high as 7.3%.
| Key takeaway: If the rate of inflation is higher than interest earned in a cash ISA, look for other options |
One thing to consider, regardless of inflation and interest rates, is that all money earned through interest in an ISA is tax-free. This makes them a more viable option for those in higher tax brackets, even during periods where money isn’t growing as fast as the economy.
Is it possible to protect your savings from inflation?
If you’re worried about keeping your savings safe from rising inflation rates, there are steps you can consider taking to protect your money. If this is something that concerns you, keep the following in mind:
- Look for the best interest rates possible. Shopping around for the best possible interest rates could help you get the most value from your savings efforts. This could be in an ISA, or an alternative saving or investment account. The better the rate of interest, the more money it should generate.
- Consider longer term investments. Waiting it out during periods of high inflation can also work for some. Whether you’re investing in stocks and shares that are able to beat inflation rates over several years (at a risk), or investing in long term saving accounts that eventually have more generous returns (at no risk), patience is sometimes the key to success.
- Think about how much to put aside and how quickly you might need it. It could be that you’re trying to save a specific amount, rather than build up the biggest figure possible. If you have a set target in mind for a fixed purchase or expense, investing in an ISA with a less favourable rate of interest isn’t necessarily a bad thing. It’s faster and easier to withdraw funds, with some accounts letting interest build up month-on-month, rather than annually.
If this helps you to get to your savings goal quicker then it could still be useful. Making this purchase as soon as possible also safeguards against future price rises caused by inflation – which in turn might even reduce the total amount you need to save in the first place.
What are the alternatives to cash ISAs
If you do decide to shop around and consider other types of savings accounts, there are a handful of alternatives to check out. Here are some of the most common, as well as what to keep in mind for each:
- Traditional savings accounts. Savings accounts which provide instant access, and work in much the same way as current accounts, are the most easily accessible alternative. These will vary in how much they offer account holders, but tend to have higher interest rates when the Bank of England base rate is higher. With the rate currently sitting at 5.25% (as of June 2024), some of these accounts will offer more to investors than cash ISAs. This all depends on the provider.
A smart way to decide whether an ISA or a savings account is the best option, you could use the following equation to work out what interest rate you’d need on an ISA to save more. Take the rate of the ISA you’re looking at and times it by:
- 1.25 if you're a basic-rate taxpayer
- 1.66 if you're higher-rate taxpayer
- 1.82 if you're a top-rate taxpayer
The sum of this can then be directly compared to the interest rate of a savings account to see which would save you more when tax is factored in. The higher number is what offers you the better rate for saving..
Keep in mind: These accounts are not tax-free. That means if you go over your personal allowance, you’ll have to pay tax on interest earned. This will be taxed at the rate of the band you find yourself in. - Top-paying current accounts. Some current accounts make it possible to link your savings and current account, meaning that both have interest paid on them. This could be a useful alternative if you want to keep a lot of your money readily accessible, with no fixed saving goal in mind. They do offer generous interest rates in some cases, but it’s again at the discretion of the provider.
Keep in mind: These accounts are usually capped at around £5,000 contribution limit per year or less. This is a big step down from the £20,000 which ISAs allow you to save. Again, any money earned above a personal allowance will be taxed. - Money market funds. This low-risk investment effectively sees someone park their money in a low-yield investment. This might be because they aren’t sure what to invest in properly yet. With interest payouts decided by the Bank of England rate, periods of inflation are usually a good time to turn to money market funds.
Keep in mind: Savings for this kind of account tend to be lower, as they’re usually intended for people who are looking to use the money sooner rather than later. - Premium bonds. This unique system doesn’t rely on interest payments at all, but rather a monthly prize draw. For every £1 you invest, you have a chance of winning a prize of up to £1m. This is run by National Savings & Investments (NS&I), who are responsible for paying the prize. The current average rate of growth for a normal account is 3.7%, although this is not a guarantee. You could earn more or less, all dependent on luck.
Keep in mind: Your chances of earning any money here are random. While you can’t lose money, you may see no gain on your capital at all if you’re very unlucky.
What other kinds of ISAs are available?
Traditional cash ISAs aren’t the only option on the market. If you’re looking for something else which could help you with savings, consider any of these:
- Lifetime ISAs. Lifetime ISAs are capped at £4,000 per year, but will see the Government match your investment by 25% (to a maximum of £1,000) every 12 months. You have to be aged 18 to 39 to open one of these accounts, but you’re able to continue contributing until you’re 50. You must use the cash to either buy your first home or for your retirement. This means you can’t access the cash unless you are buying that first property, are over 60, or have a terminal illness.
- Junior ISAs. This account allows an amount of up to £9,000 to be added to an ISA for any child under the age of 18. Interest rates for these accounts tend to vary. So, shopping around for the best deal is smart. Your child will gain full access to the account when they turn 18.
- Stocks and shares ISAs. Also known as an investment ISA, this account relies on the movements of the stock market to work out how much you’re going to get back. You can choose to either use your own knowledge to invest, or place your money in an investment portfolio created by an expert (usually for a small fee). Your annual investment limit for an investment ISA is whatever remainder you have of the yearly allowance (which totals £20,000 for 2024/24).
- Innovative finance ISAs. This kind of ISA makes it possible to invest in peer-to-peer lending. You lend money to a business or individual via a peer-to-peer lending platform, with the initial loan returned with a fixed interest rate. The possible issue here is if the loan isn’t repaid you could lose your investment. Because of this risk, these kinds of ISAs tend to have much higher rates of interest.
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