Some people wonder what the benefit of saving within a tax-free ISA is if they already have a separate tax-free personal savings allowance.
But despite the PSA, cash ISAs can still be a good option for savers.
Better option for long-term savings
The tax-free benefits of an ISA go beyond one year. The current ISA limit allows you to invest up to £20,000 each year. You can continue to earn tax-free savings on this investment for years to come and increase your balance by topping it up every year. If you regularly save the maximum in an ISA, you could soon earn a considerable amount of interest. But thanks to ISAs' tax-free benefit, you won't pay any tax — even if the interest you earn exceeds the PSA limit.
Plus, even when ISA rates are low, you’re still more likely to get a better interest rate in a fixed rate ISA account than a normal savings account. So, if you are able to lock your money away, you could get a higher return with a fixed term ISA than some of the account types covered by the PSA.
Couples can inherit each other’s ISA allowance
ISAs can be more tax-efficient than other savings accounts when it comes to inheritance.
Married couples or those in civil partnerships can inherit their partner’s ISA allowance. This means the surviving partner can save a larger amount in an ISA without paying tax.
For example, if a person had £60,000 worth of ISA assets, their widow(er)'s ISA allowance would increase by £60,000. This even applies if the surviving spouse is not inheriting the ISA assets. So, if the deceased partner had left their ISA funds to their child, the partner would still be entitled to increase their ISA allowance by the same amount. However, they would need to fund it separately by paying the equivalent sum into an ISA in their sole name.
The bereaved spouse can claim an increased ISA allowance up to three years after the date of the death of their partner, or if longer, 180 days after the estate has been administered.
Eliminates risks associated with rising interest rates
If interest rates rise, you could exceed your PSA and become liable for tax.
Saving your money in an ISA will mean you can be sure that you will not be charged tax (providing that you do not exceed your annual investment allowance of £20,000).
Investing in an ISA guarantees that any interest will remain tax-free no matter how high the interest rates rise.
These are just some of the reasons why ISAs can be an attractive savings choice. For more information on what to consider before investing in an ISA, visit our list of the pros and cons of cash ISAs.
