In his latest market update, Paragon Bank Savings Director says that ISAs still have an important role to play in the savings mix and that advice to ditch the tax wrapper could be premature.

All evidence suggests that from a market-wide perspective, 2022 may be one of the quietest ISA seasons on record. Bank of England data for March showed subdued ISA balance growth in March – a month in which we typically see a strong increase - and I’m sure April numbers won’t show a positive story.

There could be a number of reasons for this. Rates offered across savings accounts have been at historically low levels in recent months and the returns on offer maybe haven’t compelled people to ensure they are using their ISA allowance. The cost-of-living issue is also starting to hit household budgets, which may inhibit people’s ability to save.

Additionally, there have been prominent market commentators actively advising people not to save in an ISA this year, or even to move savings already within an ISA to non-ISA accounts.

Short-sighted

For me, this is short-sighted and doesn’t reflect the different demographics and needs of the nation’s savers.

The main argument being used by commentators is that the majority of people don’t pay tax on their savings because of the personal savings allowance (PSA) introduced in 2016, plus that the rates offered on non-ISA accounts have typically been higher than those within an ISA. 

It’s certainly true that the PSA removed some of the incentives to save within an ISA wrapper.

Basic 20% rate taxpayers can earn up to £1,000 interest a year from any and all savings without paying any tax on it; after that their interest is taxed at 20%. Higher 40% rate taxpayers can earn up to £500 a year; after that their interest is taxed at 40%. Top 45% taxpayers don't get a PSA – all their interest is taxed at 45%.

However, there is a strong cohort of savers focused on building a strong cash savings position who can and will continue to benefit from the tax allowance an ISA can offer in the long term, particularly if you are a higher rate taxpayer.

A higher rate taxpayer needs a savings pot of just over £24,000 before they start to incur interest on their savings, based on the current top five-year ISA rate of 2.1%.

Whilst that may seem an amount out of reach for many savers, a savings pot can build quickly for a variety of reasons. Saving regularly can steadily build a healthy balance over a period of time, whilst life events – inheritance, a bonus at work, the release of equity from a property sale – can result in a cash windfall.

Additionally, we have been in a low interest rate environment as the Bank of England slashed the Base Rate to stimulate the economy during the pandemic. This is now being reversed as the Bank contends with soaring inflation and we have seen a spate of recent Base Rate increases.

Although not wholly and exclusively influenced by the Bank Base Rate, savings rates have also been drifting up and should return to levels we saw before the pandemic.

Crystal ball

Nobody has a crystal ball to say for certain how rates will differ between ISA and non-ISA savings accounts, but to advise savers to ditch their tax allowance based on rates today could lead to people incurring tax in the future unnecessarily. Additionally, individuals who may be lower rate taxpayers today could also find themselves in the higher rate band in years to come.

If you were currently earning a rate of 2.1% for 12 months, rising to 3.5% in year two, and 4.5% in year three, a pot of £60,000 would earn £6,060 in interest over three years. In this scenario, somebody earning £60,000 a year would pay £2,224 in tax on their savings.  

It’s impossible to offer one-size-fits-all type advice to savers as each individual has different requirements and savings goals. Despite a quiet 2022 ISA season, ISAs remain incredibly popular. Government statistics show that there were 9.7 million subscribed cash ISAs in 2020 (the latest numbers available), with the amount subscribed rising by £7.1 billion compared to the previous year.

At Paragon, our customers certainly value the ISA tax allowance and we experienced one of our busiest days ever on 4 April as customers made sure they utilised their full allowance.

Why? Because they have healthy savings balances already within the ISA wrapper and they want to ensure they don’t pay any tax unnecessarily on their money.

This article was first first published in The Money Pages.