How cash ISAs work

A cash individual savings account (ISA) is a type of savings account where you don’t have to pay tax on any of the interest you earn on your money.

Here, we explain exactly how cash ISAs work and why it’s important to always compare rates on other types of savings accounts before opening one.

ISAs: the rules

At the start of every tax year, you are given a new annual ISA allowance.   For the current 2021/22 tax year which began on April 6 2021, this allowance is £20,000. Once you’ve reached this limit then you can’t put any more money into ISAs until the next tax year starts. 

You can put your whole allowance into a cash ISA, or you can put it in a stocks and shares ISA or a peer to peer lending ISA. Alternatively, you can split your allowance between all three of these.

If you don’t use your whole ISA allowance each year, you can’t roll the unused part over to the next tax year. For example, if you put away £15,000 this year, the remaining unused £5,000 of your allowance is wiped when the new tax year starts.

Stocks and shares ISAs and peer to peer lending ISAs (known as innovative finance ISAs) are usually best suited to those with an appetite for risk, and who can afford to leave their money untouched for a while.

Cash ISAs are more appropriate for those who are risk-averse, and who want peace of mind that they’ll definitely get back what they put in, plus interest. They can be useful if there’s something big you’re going to need money for imminently, for example if you want to help your children out with a wedding or a house deposit, or maybe because you’re planning some home improvements for yourself.

Under HM Revenue & Customs (HMRC) rules, you are only allowed to have one cash ISA open each tax year. So whilst you can have three different types of ISA each tax year, i.e. a cash ISA, a stocks and shares ISA and an innovative finance (peer to peer) ISA, you are not allowed to have three different cash ISAs – even if you stay under the £20,000 annual allowance.

Different types of cash ISAs

Not all cash ISAs are the same. Here’s our rundown of the different types you can to choose from.

Instant access cash ISAs

If you want to be able to make withdrawals at any time, instant access cash ISAs enable you to take your money out whenever you want without penalty. Rates on this type of account can often include a short-term bonus, so keep an eye out for this and make a diary reminder to switch again at the end of any bonus period..

Fixed rate cash ISAs

With a fixed-rate cash ISA, the interest rate you earn won’t change during the account term, but you cannot usually access your savings during this period. If you do need to take out your money within the fixed rate term you may face an interest rate penalty. In return for giving up your ability to withdraw money at any point, fixed rate cash ISAs typically pay higher rates of interest than instant access accounts. Terms vary from 1 to 5 (or more) years and you would expect to get paid a higher rate of interest, the longer you lock your money up for.

Notice cash ISAs

A notice cash ISA, as the name suggests, requires you to give notice each time you want to make a withdrawal. For example, if you take out a 30-day notice ISA, you’ll need to notify your provider 30 days before you are able to take any money out. Again, in return for having less flexibility on withdrawing your money, you should expect to receive a higher rate of interest than with an instant access cash ISA.

Whichever type of cash ISA you choose, remember that HMRC only allows you to open one cash ISA each tax year. You can find some of the current best Cash ISA rates in our article Best cash ISA rates – which cash ISAs pay the most interest? which is updated weekly.

You can transfer old cash ISAs

If you have money in a cash ISA which you opened a while ago, it’s worth checking the interest rate as providers have a habit of enticing you in with market leading rates, and then dropping them over time. If the interest rate you’re earning on it is pretty low,  Instead of leaving your money there, it may be possible to transfer it into a new cash ISA so that you can benefit from higher returns.

Any money you transfer from cash ISAs won’t affect your current annual ISA allowance. If you’re transferring an ISA that you’ve paid into in the current tax-year, you have to move all of the current year contributions you’ve made across to your new account. For ISA balances from previous tax-years, you can choose to transfer all or some of your savings.

If you’d prefer to transfer to a different type of ISA, you can move any money built up in a cash ISA into an investment ISA or an innovative finance ISA without losing the tax benefits.

Remember though, not all ISA providers will accept transfers, and there may be charges involved if you switch, especially on investment ISAs or innovative finance ISAs, so always check with your provider.

Under flexible ISA rules, you can withdraw money from an ISA and return it within the same tax year, without this counting towards your annual ISA allowance. This can be useful for managing cash flow during the year, without missing out on your annual ISA allowance – however not all ISA providers offer a ‘flexible ISA’ so be sure to check with your provider before you withdraw the money. It’s also worth noting that you can’t use the flexible ISA features in combination with a transfer. So if you have withdrawn cash from your cash ISA and plan on using your flexible allowance to pay it back in, you’d need to pay the cash back into your existing cash ISA before you make your transfer.

Whilst it’s usually a simple and straightforward process to transfer an ISA, there are specific rules around how to move ISA cash so it’s important you check with your provider before doing so. The new provider will give you an ISA transfer form and this will enable it to move the money across for you whilst retaining its ISA status. Otherwise, if you simply withdraw the money yourself, you will lose it’s ISA status and any tax benefits associated with it.

Is a cash ISA better than a regular savings account?

Before you open a cash ISA it’s worth checking the rates offered by other types of savings account to make sure you’re getting the highest interest rate possible on your money.

You can earn up to £1,000 in interest each year in any type of savings account without paying tax, thanks to the personal savings allowance (this drops to £500 if you’re a higher rate taxpayer and there’s no personal savings allowance if you’re an additional rate taxpayer). Unless you have a very large savings balance, this means your returns will usually be tax-free anyway. For example, if you put your money into a savings account paying 1.2%, you’d have to have a balance of more than £83,000 for the interest you earn this year to exceed the PSA, or more than £41,500 if you’re a higher rate taxpayer.

This does beg the question, is it worth opening a cash ISA, or should I stick with a regular savings account?

This is something we are asked a lot and the question is not always as straightforward as it might seem. On its simplest level, often regular savings accounts can offer higher rates of interest than cash ISAs, so if you are looking for a short term place to hold your money you may well be better off using a regular savings account.

If however, you are looking for a longer term home for your money and you have meaningful savings, then an ISA has a couple of benefits.  Firstly, cash ISA interest doesn’t count towards your personal savings allowance, so if you do have a large amount of savings and think you might use up this allowance, cash ISAs are still very worthwhile.

A cash ISA could also be attractive if you are considering transferring it to a stocks and shares ISA in the future, but don’t want to invest right now. By using a cash ISA, you can make use of your annual allowance each year, which allows you to transfer to an investment ISA at some point in the future when you are ready to invest. Finally, it’s also worth noting that the personal savings allowance was only introduced recently, and so there is always a chance that a future government might remove this tax incentive. No one can predict the future, but protecting money in an ISA wrapper may offer protection against such an eventuality – and if you don’t use your annual allowance, you lose it and won’t be able to move more than £20,000 a year into an ISA in future.

If you’re not sure whether a cash ISA is right for you, or whether a different type of ISA might be more suitable, you may want to consider seeking professional financial advice. You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guides on How to find the right financial advisor for you.

Do you think cash ISAs are a good idea, or do you save into a different type of ISA? We’d be interested to hear from you. You can join the money conversation on the Rest Less community or leave a comment below.

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