It has always been a source of frustration for me that banks and building societies offer lower interest rates on cash Isas compared to taxable accounts. For example, Charter Savings Bank currently offers 6% on its taxable one-year account, but only 5.2% for its one-year cash Isa deal. This begs the question: why do they justify this difference in rates when it likely costs them the same to service both types of accounts?
Isa rip off: Many banks and building societies pay less interest on cash Isa deals than they do on their standard savings rates.
Ed Magnus of This is Money replies: You are correct in noticing the significant gap between the best taxable savings accounts and cash Isa rates. Charter Savings Bank, for instance, offers the market-leading one-year fixed taxable account at 6%, while their best one-year cash Isa is only 5.2%. Other banks also have similar disparities in their rates. Close Brothers Savings, for example, offers a one-year fixed rate savings account at 5.85%, and a one-year cash Isa at 4.85%. In one year, this difference can add up to £200.
While this gap may not have bothered savers in the past when interest rates were low, it has become a more pressing issue as the best savings deals now offer meaningful returns. Many savers are at risk of exceeding their personal savings allowance, making the tax protection provided by cash Isas even more crucial. As a result, the appeal of cash Isas is increasing.
Despite this, savers continue to pour billions into Isas, with a record-breaking £3.3 billion deposited in May alone. Savers have shifted a total of £21.5 billion into Isas in the past three months.
We asked Anna Bowes, founder of the advice website Savings Champion, for her thoughts on why so many savings providers offer lower rates on their Isa accounts compared to their standard savings deals.
Anna Bowes replies: It is indeed frustrating that many banks and building societies behave this way, although it hasn’t always been the case. Prior to rates dropping to record lows in 2012, providers were willing to pay higher rates on cash Isas to attract savers and fund their lending books. However, the need to raise money from savers decreased with the introduction of the Funding for Lending Scheme and the Personal Savings Allowance in 2016.
Furthermore, there are additional administrative elements involved with Isas, such as reporting to HMRC and resolving any mistakes in opening duplicate Isas. Additionally, fixed-term cash Isas must allow customers access to their money within the term, albeit with a penalty. This lack of certainty on the provider’s end contributes to lower rates.
The recent focus on bond rates and the lack of competition in the Isa market have worsened the situation. However, with interest rates rising, the personal savings allowance is being utilized quickly. It is time for Isas to become more competitive again to benefit savers.
The Funding for Lending Scheme, launched in 2012, aimed to encourage banks to increase lending by providing funds at lower rates. Banks were incentivized to boost lending by lowering interest rates and increasing the availability of business loans and mortgages. This led to a decrease in competition and rates for cash Isas.
In conclusion, while banks and building societies may have valid justifications for offering lower rates on cash Isas, it is time for them to reconsider and provide more competitive rates to help savers maximize their earnings.
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