Recent HMRC statistics reveal that there was a decline in ISA subscriptions just one year after the personal savings allowance (PSA) was introduced in 2016. Anyone who's looked at the returns that can be had on ISAs compared to non-ISAs will have an idea why.
What's more, the latest Moneyfacts.co.uk statistics show that the average ISA rate has fallen by about a third since 2013, from 1.74% to 1.18%, so it's not just the competitiveness of non-ISA savings options that has dampened the market. As you can see in the table below, these two factors have combined to make it quite difficult for cash ISAs to compete – despite some providers improving their rates of late.
Note: Al Rayan Bank and Gatehouse Bank operate under Islamic finance principles, so the rates displayed represent the expected profit rate. Simple interest is shown and not compounded. Source: Moneyfacts.co.uk
Following the introduction of the PSA, which means that basic rate taxpayers can now gain £1,000 in savings income per year without having to pay tax on it (£500 for higher rate taxpayers), most savers have been able to avoid paying tax on their savings without turning to an ISA. Indeed, Rachel Springall, finance expert at Moneyfacts.co.uk, reported that 95% of people pay no tax on savings income (according to an Office of Tax Simplification report).
This means that "there would no doubt be repercussions if the Government were to decide to pull the PSA, or even if interest rates were to rise considerably over the next few years," said Rachel. "Savers would need a rate of 5.00% on a £20,000 investment" to start having to pay tax as a basic rate taxpayer.
This may seem unrealistically high at the moment, but if rates overall continue to rise – perhaps spurred on by another base rate rise or two – savers could very well have to start worrying about taxation, especially if they have a large pot of non-ISA savings at the moment. But that shouldn't be the only reason to consider these accounts.
"Some steps have been put in place to make ISAs more appealing, such as a large increase in the ISA allowance to £20,000 and a new rule allowing money taken out of an ISA to be replaced during the same tax year without consequences," Rachel stated. "Help to Buy ISAs, Junior ISAs, Innovative Finance ISAs and most recently the Lifetime ISA are also now around to appeal to different types of savers, while people are using stocks and shares ISAs more too."
Rachel added that "according to our data, 90% of Cash ISAs today allow transfers in from other Cash ISAs," which means those that have accumulated ISA funds over the years can keep transferring them to better rates. However, this may not be enough to make up for the lower interest rates, which may very well be why Rachel found that "the number of subscriptions to Cash ISAs fell by 1.6 million between the 2015-16 and 2016-17 tax years [according to HMRC statistics from April 2018]."
Overall, if you plan to have a savings pot large enough to make you worried about taxation, or if you want to take advantage of the Government benefits that come with the Help to Buy and Lifetime ISA, these tax-free accounts are still worth considering. At the same time, Rachel acknowledges that "the ISA market could still do with an injection of better interest rates and more competition outside of ISA season, otherwise we could see even less subscriptions over the next few years as ISAs continue to fall out of favour."