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The cash mini-ISA is arguably the easiest component of the ISA regime to understand and is a good way to get tax-free interest without risking your capital. But there are certain things to bear in mind to get the one that best suits your needs.
When they were launched cash ISAs were regarded as a poor relation to their stocks and shares cousin. But today, with stockmarkets still requiring a greater attitude to risk than deposit accounts, the cash ISA is finally getting its day.
"Anyone who's not using their full £7,000 ISA allowance for stocks and shares should definitely consider a cash ISA, even if it's only for short-term savings,” says John Davison, Managing Director of Myers Davison Ginger Ltd. “It doesn't cost anything and, as savings institutions tend to set their cash ISA rate slightly higher than the gross interest rate on their savings account, even non-taxpayers are likely to be better off with an ISA.
The benefits are even clearer for taxpayers. To ensure the buying power of your savings increases, you need it to grow at a rate higher than inflation, currently around 2.9 per cent. For a basic rate taxpayer, this would mean having a savings account with an interest rate of at least 3.63 per cent gross. For higher rate taxpayers the interest rate required is 4.84 per cent gross, something you won't find anymore without having to take some risk with your capital.
This, coupled with the recent poor performance from the stock market lowering confidence, has made the cash mini-ISA increasingly popular in the last couple of years, as Inland Revenue figures demonstrate. In the first year of ISAs (1999/2000) some £12,306 million poured into the cash element compared to £16,054 million for the (then) much sexier stocks and shares version.
However, a couple of years down the line the situation reversed. In the 2001/2002 tax year £17,058 million went to cash ISAs while only £11,319 million was placed in stocks and shares ISAs. And the Revenue's forecasts for last tax year reveal a similar picture with cash ISAs taking twice as much as stocks and shares ISAs (£18,526 million compared with £9,123 million).
If you're considering making your £3,000 part of next year's cash ISA figures, it's important you pick a product that suits your needs. Although the difference between the best and worst is only likely to be a matter of a couple of percentage points, with interest rates and inflation low, every extra penny counts.
When it comes down the nitty gritty – the interest rate – best buy tables offer invaluable assistance, but even armed with these you can be caught out. “Some providers do the old rate trick, luring people in with a high headline rate that they then cut back once they've attracted enough business,” explains John. This little trick means it's important to pay attention to the rate being paid on your cash ISA even after you've opened it – something John recommends doing every six months or so.
Another common trick that allows ISA providers to bump up a rate and secure the top spot in a best buy table is the bonus. These are typically added after you've held an account for six months and are becoming increasingly common.
Look at all the details when choosing between ISAs cautions John. “Many best buys include short term bonuses so, unless you only intend to invest for the length of the bonus period, you might be better off with a plain vanilla account paying a good rate with no restrictions or bonuses.”
Looking at the AER (annual equivalent rate) can help to put these rates into context. This is a notional rate showing the actual interest rate you would receive if you held the ISA for 12 months.
Additionally, assuming rates did not change, the returns on the ISAs with bonuses would slip still further in the second year.
There is one way to take advantage of these short-term bonuses. “Be a rate tart,” says Myers Davison Ginger's John Davison. “The majority of people just put their money into an ISA and leave it; but if you're happy to transfer between ISAs then you can really take advantage of these special bonuses.”
Transferring is easy. There are no limits on the number of times you can do it and it doesn't affect the tax-free status of earlier years' ISA contributions. John further explains. “Your new ISA provider will give you an application form for their ISA which you complete and send off to your current provider. I then shouldn't take more than 30 days to complete the transfer."
But before you dash out to rearrange your cash ISAs, watch out: there can be catches. Unfortunately, not all providers will allow you to transfer your existing ISA to them and some will penalise you if you leave them.
While not being able to move your cash ISA to another provider may be frustrating, it's definitely not as annoying as finding yourself hit with a charge from your existing provider when you transfer. Thankfully the majority don't penalise you for moving and some will only demand a week or more's notice. Others will dock interest, especially if it's a fixed-rate product, but the worst offenders will charge you a fee if you move your ISA money to another provider.
“Don't wait until you want to move before you think about these penalties,” says John. “When you're opening an account or transferring to another provider look out for these exit charges. If you want to transfer again they could easily wipe out any advantage you got from the higher rate.”
Of course the rate isn't everything. As well as looking for the best rates, it's also important you don't lumber yourself with a cash ISA that doesn't do what you want it to do. For starters, it's worth checking the small print if you're not going to put in the maximum £3,000 allowance (or more with all those previous years' contributions you'll want to transfer) as some providers offer tiered rates. For example alender could on its cash ISA pay 3.00 per cent on balances over £10, 3.25 per cent once you've saved £1,000, 4.00 per cent when you've got the full year's allowance in, and 4.25 per cent when you've got more than £9,000 saved.
While this may be annoying, especially as the advertisements will promote the higher rates and leave the lower rates for the small print, some ISA providers aren't even interested unless you've got the full £3,000. This is especially true on the fixed-rate products, although a few of the variable rate ones also set their minimum balance at £3,000.
Another feature that is relatively common on ISAs is a notice period, with about a quarter of them coming with a tie-in of anything from one week to 90 days – or longer if it's a fixed rate bond ISA. But while these products used to bring advantages it seems this has changed. The premium for tying your money up appears to have disappeared, as interest rates have fallen and the instant access products will often offer the same or a better return.
But before you get submerged into fixed rates, bonuses and notice periods it's worth considering whether the cash ISA is your best option. If you have debt such as a credit card balance then, because the interest rate on this will typically be higher than any cash ISA available, it makes sense to pay this off rather than save.
Alternatively, you might think cash is for cowards and that it's the perfect time to jump back into the stockmarket – in which case you might just want to save the full £7,000 allowance for a stocks and shares ISA.
But a final note: many finance gurus always recommend squirreling away three months' net salary in case of emergencies. A cash ISA is as good a place to stash this cash than anywhere else.
<<br /> Tessa-only ISAs
Next March marks the demise of the Tessa, as the final wave of these mature. But to keep the name, and tax-free benefits, alive, Tessa-only ISAs, known affectionately as Toisas, were created. These operate in exactly the same way as cash ISAs, having similar rates and conditions but are only available if you have a maturing Tessa.
The rules on moving to a Toisa are straightforward, with Tessa providers set up to move your money to their Toisa product or, less happily, help you complete the necessary paperwork to move to another provider, but there are some catches. You have exactly six months from the date your Tessa matures to transfer to a Toisa. If you're moving to another provider, make sure you don't take the money out rather than transfer it, as this will make it impossible to open a Toisa with the mone.
There are limits on the amount you can move to a Toisa. The Inland Revenue has restricted it to just the capital (up to the £9,000 maximum contributions limit) so any growth you will have received on your Tessa cannot be moved into a Toisa.
Cash mini ISAs rules
Under the ISA rules investors can place up to £3,000 into a cash ISA in any tax year. Naturally, as with anything controlled by the Inland Revenue, there are conditions attached:
A maximum of £7,000 can be invested into ISAs each tax year, either as up to £7,000 into a stocks and shares ISA or as up to £3,000 in a mini cash ISA, a further £3,000 in a mini stocks and shares ISA and £1,000 into the life assurance component (mainly offered by Friendly Societies).
Investors cannot open maxi and mini ISAs in the same tax year. This means that if you open a stocks and shares only maxi-ISA you will not be able to open a cash mini ISA alongside it. There are exceptions to this. A few maxi ISA managers offer the three different ISA components within the maxi wrapper, so you will still be able to hold cash within a maxi ISA.
Withdrawals cannot be replaced. So if you put the full £3,000 in a cash ISA, then withdraw £1,000 to pay for a holiday or home improvement you can't top your ISA up to the full £3,000 later that tax year.
CAT standards are available for cash ISAs. To qualify for a CAT standard, a cash ISA must have no charges; a minimum investment of £10 or less; no restrictions on withdrawals or payments; a facility to make withdrawals within seven working days or less; and an interest rate no less than two basis points below the base rate.
It's also important to remember that ISAs might not be around forever. When the government introduced them in 1999 it stated that they would run until at least 2009, although it has only committed to the current contribution levels until April 2006 so these may change before 2009.
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