Should I use and ISA or a saving account?

nick323f

Hi Guys,

OK so I have no savings at the moment. But I think I should start. I have been reading alot about ISA's this last week and was thinking that this should be the first thing I should start.
But my friend suggested that the interest on the ISA is paid at the end of the year so is not compound through the year.
He suggested that I should be looking at a savings account which pays intested every month, hence compound intested over the year.
Then he said I should everything from there and put it into the best rate ISA I can find in April.

What do you think?

Also, If earnings on a savings account is taxed, when does the government take this tax? is it removed before it is paid to you buy the banks or is it up to me to declair this interst on my tax return?

Thanks for reading
Nick

lisyloo

But my friend suggested that the interest on the ISA is paid at the end of the year so is not compound through the year.

Some are paid monthly and they give you the GROSS rate (divided by approx 12 per month)
This would of course compound up so the amount you'd get would be the AER (annual Equivalent rate). This is the equivalent of getting it all in one go.

Some ISAs are paid annually.
In this case the GROSS and AER are the same as there is nothing to compound.

Best thing to do is just look at the AER.
To be honest with todays small interest rates, it's a minmal difference, but the correct figure is AER.

He suggested that I should be looking at a savings account which pays intested every month, hence compound intested over the year.

The compounding difference is minimal.
The saving on an ISA is potentially 40% (depends on your tax rate).

What do you think?

Go for an ISA and look at AER. This take into account the compounding.

Also, If earnings on a savings account is taxed, when does the government take this tax? is it removed before it is paid to you buy the banks

Yes at 20% (basic rate)

or is it up to me to declair this interst on my tax return?

If you pay 40% tax then yes, you must pay the additional 20%.
However note you might be able to claim back some 40% relief on any personal pensions you contribute to so you actually get a tax refund.
If you pay basic rate you don't need to do anything as the bank take it.

cloud_dog

Pretty much what lisyloo says..... Find the best paying account, for ISAs use the gross interest rate, for normal accounts use the net interest rate.

As you are just starting out and possbily saving monthly, and with rates pretty low, you may find that a regular saver account is the way to go, then at the end of the 12 months move the amount in to the best account you can find (ISA or not), and start another regular saver.

The only thing to bear in mind is that your ISA allowance is only valid during the tax year, so use it or lose it. Previous years deposits will remain under the ISA umberella (tax free)

lisyloo

for ISAs use the gross interest rate, for normal accounts use the net interest rate.

I think you are referring to gross of tax and net of tax here.

However the gross amount is slightly misleading because in a monthly account it's too low as it will be compounded.

Better to compare AER and take into account tax.

I realise there are two concepts here (the tax and the compounding) hence the confusion.

Bear in mind also that ISAs are tax fee for LIFE.
This is potentially a long time and therefore a potentially very valuable tax break.

nick323f

Hay thanks for the advice guys much apreaciated the time you take on this for me.

May plan is to set up a direct debit of about £100 to £150 per month to pay into a saving account. We need to get loads of work done on the house so whenever the total get to an amount that will pay for the next bit, e.g. £2000 for the kitchen, I'll spend it.

I didn't realise that the government takes the tax from the bank before you get the interest! This must be very complex for people who are on incomes below there tax thresh hold. (and no I'm not a higher rate tax payer)

LongTermLurker

I didn't realise that the government takes the tax from the bank before you get the interest! This must be very complex for people who are on incomes below there tax thresh hold. (and no I'm not a higher rate tax payer)

It's not the government that takes the tax, it's the bank that deducts it and pays the government (HMRC). Anyone who doesn't pay tax just fills in a form and sends it to their bank, then the bank doesn't deduct any tax.

You mention tax returns, which is an interesting point - if you ever have to fill out a tax return, ISAs don't have to be mentioned at all, which makes accounting much simpler.

Finally, although you don't pay high rate tax now, could there be the remotest chance that you might in the future? Consider 3 things:

1. Your income increases beyond the threshold - this doesn't have to be your wage; it could be wage + non-ISA interest + dividend income + rental income or lots of other things
2. The threshold decreases below your income
3. Your non-ISA savings/investments are so large that you end up paying tax in retirement when it could have been avoided and you don't qualify for any means tested benefits

There are many reasons to use your ISA allowance and few reasons why you shouldn't. Don't be blinded by the seemingly low interest rates, that's only a part of it.

Loughton_Monkey

nick323f wrote: »

May plan is to set up a direct debit of about £100 to £150 per month to pay into a saving account. We need to get loads of work done on the house so whenever the total get to an amount that will pay for the next bit, e.g. £2000 for the kitchen, I'll spend it.

This is entirely up to you. OK, if you are going to save and spend after a year, then might as well have the tax free element, but in later life, you may well regret not using it to save for a much longer period. Most of us see the ISA as an opportunity given every tax year, to 'trap' money in and roll up for 10 years or more gross. Every 5th April that you didn't fill it is a lost opportunity.

nick323f wrote: »

I didn't realise that the government takes the tax from the bank before you get the interest! This must be very complex for people who are on incomes below there tax thresh hold. (and no I'm not a higher rate tax payer)

Not complicated at all. These people simply fill in an R85 form and interest is paid gross.