Tax on savings vs Tax free ssavings rates - how to work out which is best deal

Bark01

Hi,

Can someone confirm I'm working this out correctly.

I have a savings account with a 5% interest rate (taxable) and a cash ISA with a 3% (tax free) saving rate.

Does my savings account just have income tax applied to it (20% if below earnings threshold) so the actual interest rate after tax would be 4% making it return more money in interest than my ISA? Is there anything else I should be aware of?

I should point out that interest on my savings account is higher because I can't take anything out for a year, so I know that’s a minus point but just want to check my understanding of the tax free benefit of an ISA is correct.

thanks

bryanb

Yes those figures are right. Remember if you close the ISA you lose the tax free status in future years on that cash, circumstances could change. What will be the rate on savings account after 1 yr?

Bark01

The savings account turns back into a normal account so that is an issue, I was just checking my thinking was correct.

thanks

blueberrypie

Bark01 wrote: »

I should point out that interest on my savings account is higher because I can't take anything out for a year, so I know that’s a minus point but just want to check my understanding of the tax free benefit of an ISA is correct.

Yes, but bear in mind that the money you have in the ISA "wrapper" continues to earn tax-free interest for as long as it remains there. In other words, it's not just the interest that you earn this year that is tax-free, but also the interest paid in future years - on the money you contributed this year as well as all interest accrued from now on. That's when the real benefit of ISAs shows - in the compound interest in future years.

bloaty

But the big question is how can the banks pay a higher rate on these than on an ISA?

Ifts

bloaty wrote: »

But the big question is how can the banks pay a higher rate on these than on an ISA?

According to this article Low rate ISA's that snatch the tax relief , its more profitable for the financial institutions to keep rates low on cash ISA's.