Cash ISAs are back on top!

Find out how to get a better return on your easy access savings with a cash ISA.

When cash ISAs rates slipped below those offered by standard savings accounts, many savers decided the tax-free accounts just weren’t appealing enough for them.

That’s understandable, but I think it’s a mistake.

It still makes a lot of sense to save as much of you can in ISAs because once the end of the tax year deadline has passed (on the 5 April each year) any unused tax-free allowance will be lost forever.

Instead, fill up your ISA to the limit if you can afford it - that's a maximum of £5,100 each tax year - then when savings rates eventually begin to recover, you’ll be able to earn a better tax-free return on more of your cash.

If you’re still not convinced, it may help you to know that the best-buy cash ISA is now offering a higher rate than the top easy access savings account (the Alliance & Leicester Online Saver Issue 7). So there’s really very little reason for choosing a taxable home for your spare cash, when the tax-free option is more attractive.

To illustrate this more clearly, here’s a quick comparison:

Top cash ISA versus top easy access savings account

I won’t dwell too much on the fact that none of the returns shown here are particularly generous. If you want easy access to your savings, I’m afraid you’ll have to accept lower returns until the climate improves. But what the table does show is how the gap in the returns widens in favour of cash ISAs with each tax bracket.

For a taxable account to match the return paid by the best-buy cash ISA, it would need to pay the following equivalent gross rates:

Of course, you can easily see there’s no way savers can earn rates this high on an easy access savings account right now. So, quite simply, cash ISAs can’t be beaten by their taxable counterparts.

If you’re feeling more convinced that cash ISAs do indeed have the edge, the next table rounds-up the top six best-buys on the market today:

Top six instant access cash ISAs

*Four penalty-free withdrawals are allowed in the first year. The rate will switch to the Halifax ISA Saver Direct variable interest rate if further withdrawals are made in this period. This is currently 0.50%.

The top 3% rate is paid on the Brighter ISA from Market Harborough Building Society. This rate includes a 0.75% bonus for a year. It’s also good news that not only is this ISA open to new money, but it also accepts transfers if you want to switch your old ISA accounts from previous tax years which are now earning dismal returns. This means you can get the same top rate on all your ISA money.

The headline rates shown for the next five best-buys are actually lower than the Alliance & Leicester Online Saver Issue 7. But remember, unless you’re a non-taxpayer - when the A&L account would be a better choice for you - the tax-free ISA options generate more interest regardless of your tax bracket.

Just beware if you choose an ISA with a bonus, make sure you check the rate you’ll be earning on your cash once it has disappeared. The chances are the returns on offer at that time will have fallen far behind the new market-leaders. In fact, this applies to any savings account you choose, tax-free or not.

At this point the First Direct cash e-ISA is worth a specific mention because, instead of paying a bonus, it offers a fixed rate of 2.65%. This would be a great choice for savers who don’t like to continually switch their savings around, since the return is guaranteed until 31 October 2011.

That said, the rate will then drop to the standard variable rate which is currently just 0.20%. Make a diary note of this date so you’ll keep track of when you’ll need to switch.

Top transfers

With the exception of the market-leading Brighter ISA, which offers the top rate for new ISA money and transfers, there are other cash ISAs out there with better rates for transfers than those shown in the table.

For example, the Santander Direct ISA has a best-buy rate of up 2.75%. However, to qualify for it, you’ll need to transfer a balance of at least £9,000. You’ll also earn the same rate with the Alliance & Leicester Direct ISA. Both include a large bonus of 2.25% which lasts for a year, so you’ll need to switch your ISA savings at this time to keep on earning a competitive top rate.

Note that transferred balances of less than £9,000 will only earn a rate of 2% (including a 1.5% bonus), so you’ll be better off looking elsewhere in this case.

Don’t discount your bank’s ISA

Finally, I would normally recommend you don’t touch your bank’s financial products with a barge pole, but occasionally good deals are on offer to existing customers. It may be worth checking whether your bank has any exclusive cash ISA deals in its range, as well as looking at the wider market.

Compare ISAs at lovemoney.com

More: Rates on cash ISAs rise | The risks of investing your ISA