Query Fixed Rate v ISA x 1.25%

FieyrP125

Hi, general query, hope you can help

On the MSE best savings rate page it states to work out if an ISA is better you should multiply the ISA rate by 1.25 for basic rate tax payers and the fixed rate saving would have to be equivalent to that to beat the ISA.

So for example, if you have £50k to invest....best ISA is 3.9% (ignoring limits for simplicity) giving tax free interest of £1,950

Using the 1.25 rule on this site suggests a fixed rate in the region of 4.875 would be needed to beat the ISA

However, this does not take into account the first £1,000 of interest earned is tax free. It does work out if the whole of the interest is taxed at 20% but it's not.

A fixed of 4.5% would beat that ISA. This would give interest of £2,250, 20% tax on £1,250 reduces this to £1000 plus the tax free £1,000. Total £2,000

Would the calculation not have be around 1.12 x instead?

Or am I getting this wrong?

Many thanks 

eskbanker

FieyrP125 said:

However, this does not take into account the first £1,000 of interest earned is tax free. It does work out if the whole of the interest is taxed at 20% but it's not.

The reference to the 1.25 multiplier is within a section relating to those who pay tax on savings interest:

How do I compare cash ISA rates to normal savings rates if I pay tax?

If you pay tax on savings interest, it's often not clear whether a higher-paying normal savings account beats a cash ISA for you.

The comparison is undoubtedly more complex if there's any desire to evaluate some of the interest not being taxable, so if that's what you want to work out then you can't use a single simple figure but need to factor in the balance and your own tax situation....

FieyrP125

Thanks for the reply

That's the point I was making, the site here says that for basic rate tax payers multiply the ISA rate by 1.25 and the result is what the fixed rate should be which will beat it...copied below

How do I compare cash ISA rates to normal savings rates if I pay tax?

If you pay tax on savings interest, it's often not clear whether a higher-paying normal savings account beats a cash ISA for you.

Yet, some simple maths can help you compare. Take the rate on the ISA you're looking at and multiply it by:

- 1.25 if you're a basic-rate taxpayer

That calculation only works if all of the interest from savings is taxed. If your first £1,000 is tax free the 1.25 calculation does not work. The above scenario on the site is if you are paying tax on interest, i.e. earning more than £1k

So am I getting this wrong or is the example above on this site wrong?

eskbanker

FieyrP125 said:

That calculation only works if all of the interest from savings is taxed. If your first £1,000 is tax free the 1.25 calculation does not work. The above scenario on the site is if you are paying tax on interest, i.e. earning more than £1k

So am I getting this wrong or is the example above on this site wrong?

Neither really - the wording on the site is perhaps a little careless but is presumably intended to convey that if all the interest on the sum concerned is taxable (e.g. for those who've already used their PSA with other savings) then the 1.25 multiplier applies, but for any other scenario the effective figure would be somewhere between 1 and 1.25, depending on the specific circumstances.

Dazed_and_C0nfused

That calculation only works if all of the interest from savings is taxed. If your first £1,000 is tax free the 1.25 calculation does not work. The above scenario on the site is if you are paying tax on interest, i.e. earning more than £1k

It's a massive oversimplification really.

Some basic rate payers can have £5,999 interest all taxed at 0%.

The majority will have just £1,000.

Some older pensioners with £1,000 taxed at 0% will have a larger tax bill despite paying 0% on the interest (tapered Married Couple's Allowance).

Explaining every permutation is tricky (or very very long winded)

FieyrP125

Makes sense

Cheers for replies