Tax-efficient ISAs have never been more popular, with £4.2 billion being saved in cash ISAs in May – a record for the month.  

We saw £12.3 billion saved into cash ISAs in April, at the end of the tax-year end, as people rushed to use their annual limit before it was refreshed on April 6th. But this early-bird ISA activity continued in May, with people moving money into a cash ISA at the biggest scale on record.  

But why are people using ISAs and why has there been such an uptick? We’ll look at a few reasons. 

HIGHER INTEREST RATES 

People are now getting more interest on their savings than they have for years, thanks to an increase in the Bank of England Base Rate. For example, two years ago the average easy-access cash ISA rate was just 0.68%, according to BoE data, but now it averages 2.72%. This means that more people will be hitting their Personal Savings Allowance.  

The personal savings allowance gives most people a tax-free limit for the interest they can earn on their savings before they’re taxed. It currently stands at £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers. Additional rate taxpayers get no tax-free allowance. Once you earn more interest than the limit you’ll pay tax on it at your income tax rate. The introduction of the personal savings allowance meant that the majority of people didn’t need to use an ISA as their savings were protected from tax, because interest rates were so low. Because rates are higher people are now breaching their personal savings allowance, meaning they are shifting to an ISA to protect the money from tax.  

FROZEN TAX BANDS 

The Conservative government froze tax bands in 2021/22 and that freeze looks set to remain in place until 2028. It means that as people get pay rises their wages are pushed into the next tax bracket. At the same time the additional rate threshold has been cut from £150,000 to £125,140 dragging more people into the highest rate of tax.  

While this has an impact on people’s tax bills, it also has an impact on their personal savings allowance. Once someone moves into the higher rate bracket, they see their personal savings allowance cut from £1,000 to £500, and once they hit the additional rate threshold, they lose it altogether. More people are moving up tax brackets and so seeing a cut to their tax-free limits, meaning they are shifting their savings to an ISA to protect it from tax.  

CUTS TO DIVIDEND AND CAPITAL GAINS TAX 

While the Bank of England figures focus on cash ISAs, we know that people have also been moving their money into investment ISAs to protect it from tax. The dividend tax allowance has been slashed in recent years from £2,000 to £500, while the capital gains tax allowance has been cut from £12,300 down to £3,000. It means that people who breach these limits face a higher tax bill – and gives a bigger incentive to move money into an ISA.  

Many investors do this through a Bed and ISA transaction, which is the process of an investment being sold in a dealing account and then purchased in an ISA so it’s protected from future tax. On AJ Bell last March and April we saw bed and ISA transactions more than double, while this year in April alone we saw a 17% annual increase in the number of transactions carried out.  

ISA CASH RATES HAVE RISEN 

In recent years savers who have opted for a cash ISA account have often had to accept a lower interest rate to do so. Often ISA rates were lower than traditional savings account, whether you were fixing or opting for easy access. However, ISA rates now appear to have risen.  

Based on Moneyfacts data the average easy-access ISA rate was higher than the non-ISA version across the past three years (see chart above). This means that people don’t have to compromise on rates to select an ISA, removing one of the barriers to using an ISA account. 

DISCLAIMER: Financial services firm AJ Bell, referenced in this article, owns Shares Magazine. The author (Laura Suter) and editor (Tom Sieber) own shares in AJ Bell.

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