Savers: Earn more interest in your ISA

The government has kept its promise to increase our tax-free ISA allowance. This is great news for all savers.

ISAs have certainly been a huge hit with UK savers. In fact, more than one in three adults are enjoying the valuable tax breaks they offer. What’s more, children can now join the party too with the launch of Junior ISAs next autumn.

Index-linking the ISA allowance

In June’s Emergency Budget, the Chancellor George Osborne pledged to increase the tax-free ISA allowance in line with RPI inflation. Since then there have been grave concerns the government would renege on its promise, and possibly even reduce the contribution limits as part of its programme of spending cuts. Thankfully that didn’t happen as it was announced earlier this month that the limits would be raised in the 2011/2012 tax year.

From 6 April 2011, savers will be able to deposit up to £10,680 in ISAs. Remember, as always the allowance will have a shelf life which expires on 5 April 2012 - any unused allowance will be lost after this date.

Inflation-busting!

The increase represents a rise of £480 on the existing £10,200 limit, which has actually been increased slightly above the latest RPI annual inflation figure of 4.6%. If the allowance had stepped up by the rise in the RPI only, it would have been set at £10,669.20. But, for the sake of simplicity, it has been increased to £10,680, which can easily be divided into 12 equal installments of £890 to suit those who like to save on a monthly basis.

Again, the new allowance can be split between cash ISAs and stocks and shares ISAs if you wish, but no more than £5,340 can be held in cash. Alternatively, if you want a more adventurous investment you can opt to put the whole £10,680 allowance into the stock market.

What a difference £480 makes

You might think an extra £480 isn’t a particularly dramatic increase to our tax-free allowance. But ISA provider, Fidelity reckons big savers could be more than £28,000 better off as a result.

This figure is based on a saver age 35 who invests the new allowance of £10,680 into an ISA every tax year. If their investment grows at an assumed rate of 4.5% a year (before charges), they could build up a nest egg worth £679,077 by the time they reached 65. This is an extra £28,803 more than if the ISA allowance remained at its existing level of £10,200 a year.

Where should you put your ISA money?

Of course, putting over £10,000 away in ISAs will be beyond the means of some savers. But you should try to use up as much of your ISA allowance as you can to take advantage of the tax breaks.

If you haven’t already opened an ISA this tax year, it’s about time you did! I realise, however, that deciding how to use up your allowance can be a little tricky. Should you go for stocks and shares, cash or a combination of both? Our guide on how to make money tax-free will help you decide whether investing in an ISA is the right choice for you.

For those who prefer the relative safety of cash ISAs, the tables below show the best places to put your money right now. Remember, you can save up to £5,100 this tax year and an extra £5,340 in the new tax year:  

Top six easy access cash ISAs

You’ll notice the top two cash ISAs from Halifax and Santander pay preferential rates to existing customers only. To qualify for the Halifax ISA Direct Reward you’ll need to have a Halifax current account and deposit at least £1,000 a month, or hold the Ultimate Reward Current Account. If you’re thinking of switching to Halifax using their dedicated switching service you’ll become eligible. All other savers will get a tax-free rate of 2.80%.

It’s a similar story at Santander where existing current account customers, or those with a Santander mortgage or investment, will qualify for a preferential rate of 3% with the Santander Loyalty Flexible ISA. Again, if you’re prepared to switch to Santander, the ISA will become open to you.

The account pays a rate which tracks at 2.5% above the base rate giving a current pay rate of 3%. But note that after 12 months your account will automatically revert to a tax-free standard rate which is currently just 0.50%. In other words, you’ll need to transfer your ISA to the new best-buy at this stage to avoid getting stuck with a rubbish rate.

A base rate tracker ISA is pretty attractive right now since the base rate is only likely to climb up from its current all time low, boosting your overall tax-free return.

Non-Santander customers will get a rate of 2.85% with the Santander Flexible ISA Issue 3. The rate also tracks the base rate but this time at a margin of 2.35%, giving a current pay rate of 2.85%. The same transfer advice applies after 12 months when the rate will slip significantly.

The ING Direct Cash ISA and the Principality BS e-ISA Issue 2 both pay pretty decent rates of 2.80%. But I particularly like the ING ISA because the rate is fixed, guaranteeing your return for the next 12 months. But even if the account falls behind the new best buy ISAs which come onto the market over the coming months, you can easily transfer without incurring a penalty.  

Compare ISAs at lovemoney.com

More: Don’t miss the new market-leading savings account! | More great news about your ISA