Best tax-free cash ISAs 2020

Want to boost your savings? Opening a tax-free cash ISA is a surefire way to make some extra cash, and they’re super easy to set up. Here’s your beginner’s guide to ISAs!

piggy bank surrounded by pound coins

Credit: Linda Bestwick (background), Aurora72 (foreground) – Shutterstock

According to our National Student Money Survey, 81% of you have at least some money in your savings – and if you’re one of them, you might want to consider opening a cash ISA.

ISAs, or ‘Individual Savings Accounts’, are basically savings accounts that let you store your money without having to pay tax on any interest you earn.

Despite a recent change in the law that means it’s unlikely you’ll pay tax any interest as a student, there are still some perks to opening an ISA which make them worth your consideration. So, buckle up as we take you through the pros and cons of opening an ISA as a student.

Other types of ISA, such as the Lifetime ISA, might be a better investment and are designed to help you save up for your first home.

What are ISAs and how do they work?

piggy bank

Put simply, cash ISAs are a type of ISA, which in turn is a type of savings account. For reference, there are five main types of ISA:

  • Cash ISAs
  • Help to Buy ISA (no longer available to new customers)
  • Innovative finance ISAs (where you’re essentially lending someone money, and they’ll pay it back with interest)
  • Lifetime ISAs
  • Stocks and shares ISAs.

As we touched on earlier, the big selling point of an ISA used to be the fact that you don’t have to pay any tax on the interest the account pays out – something you previously did have to do with the interest paid by other types of account.

But thanks to a change to the law in 2016, basic-rate taxpayers (anyone earning under £50,000 per year) can now earn a total of up to £1,000 of interest tax-free in any savings account each year. This has led some to argue that ISAs are now redundant, but we’d suggest that isn’t the case – as we’ll explain in a bit.

Unsure what interest is, or how it works? Our explanation of financial jargon is here to help.

Types of cash ISA

pennies spilling out of jar

Much like other savings accounts, cash ISAs come in two main forms:

Easy-access cash ISAs

An easy-access cash ISA allows you to withdraw your cash if and when you need to. But, crucially, you may not be able to put it back if you’ve hit the annual ISA allowance (£20,000 for the 2020/21 tax year), as this applies to the amount you can deposit and not the overall balance (we’ll explain this in more detail in a sec).

Interest rates on easy-access ISAs are usually variable (meaning they may increase or decrease in the future) and may include a tempting (but temporary) higher bonus interest when you first open the account. Bonus rates, by contrast, are usually fixed, meaning they’ll stay the same for the period they apply.

Fixed-rate cash ISAs

Fixed-rate cash ISAs come with a guaranteed (usually higher) interest rate, but your money’s locked away for a fixed period of time – usually (but not always) between one and five years.

The trade-off for these higher interest rates is that, unfortunately, you’ll be charged a penalty fee if you withdraw early. You may lose any interest you’ve accumulated, and could even lose money on your original investment if the penalty fee exceeds the interest you gained.

In other words, only go for a fixed-rate ISA if you’re happy to put your money away and leave it there.

How much money can you put in an ISA?

10 pound notes

You can put a maximum of £20,000 a year into your ISA, and this applies across all accounts if you have multiple ISAs.

It’s important to remember that it’s each deposit that counts towards your limit, not how much you actually have in there. So, if you had £30,000 in an ISA at the start of the tax year, you could still add an extra £20,000 to it over the next 12 months.

Sadly, this also means that if you deposit a grand but decide to withdraw £500 a few months later, it will still count as a £1,000 bite out of that year’s ISA allowance.

Flexible ISAs

There is some nuance to the deposit allowance if you have a flexible ISA. If you hold one of these accounts, you can withdraw and return money to your cash ISA in the same tax year (6th April – 5th April) without it reducing your allowance for the year.

So, to use the same example as above, imagine you had £30,000 in your ISA at the start of the tax year. You then put an extra £1,000 into the account, reducing your allowance to £19,000 for the rest of the year.

If, however, you then withdraw £5,000, you can then put £24,000 into the account in the same tax year: the £5,000 you took out, plus the £19,000 you had remaining on the original allowance.

Remember though: this trick only applies to flexible ISAs (each cash ISA will say if it’s flexible or not). If your ISA wasn’t flexible, your allowance in this example wouldn’t increase to £24,000, so returning the £5,000 you withdrew would decrease your remaining allowance to £14,000.

Can you have two ISAs at the same time?

You can have more than one cash ISA, but you can only open or pay into one each year. Note that you can pay into more than one type of ISA each year (e.g. a cash ISA and a Stocks & Shares ISA), just not two cash ISAs.

You can also switch from one ISA to another if you spot a higher interest rate with another provider – just check that the new ISA allows transfers and your current bank isn’t going to charge you a penalty for withdrawing the money (if you have a fixed-rate ISA).

Why should you open an ISA?

wolf of wall street money

Credit: Paramount Pictures

Admittedly, the £1,000 tax-free interest allowance for basic-rate taxpayers may make you think that an ISA is no better than your bog-standard savings account. But it’s worth remembering that all ISA interest is tax-free, no matter how much interest you’re earning elsewhere. So even if you exceed the £1,000 interest limit with your other savings accounts, your ISA interest will always be tax-free.

What’s more, the £1,000 allowance only applies to basic-rate taxpayers (those earning under £50,000 per year). As soon as you enter the higher-rate bracket (when you earn between £50,001 – £150,000 per year) your tax-free interest allowance drops to £500, and if you’re the world’s richest student and earn over £150,000 per year, you’ll have no tax-free allowance at all.

And crucially, as all ISA interest is always tax-free, it means it is hidden from the Student Loans Company. Remember, your Student Loan repayments are based on your taxable earnings, and the more you earn, the more you repay each month.

So regardless of how much interest you’re earning in an ISA account, it will never, ever be factored into your earnings – meaning it will never, ever increase your Student Loan repayments.

As a side note, when you apply for Student Finance, your parents’ taxable income determines how much funding you receive. If they put their savings in an ISA, their savings interest won’t increase their income, which in turn would reduce the Maintenance Loan you receive.

Should you open an ISA or a savings account?

confused woman shrugging

As you might have twigged by now, it’s best to be thinking long-term when it comes to ISAs.

Right now it might seem silly to think about earning over £1,000 in interest a year, or being in the higher-rate tax band. But if you save over a long period of time and secure a well-paid job, you might suddenly find yourself getting taxed on your interest after all.

Say you’ve kept all your savings in your current account or savings account since your student days, and after a few years found yourself in a situation where you’re having to pay interest on your savings.

You may now decide to move your savings into an ISA to get that interest tax-free, but there’s a catch: you can only deposit a maximum sum of £20,000 a year into an ISA.

Again, this may sound like a huge amount of money, but if you’ve already been paying into a Lifetime or Help To Buy ISA that year (something you should definitely consider!), you may not be able to transfer all your savings into an ISA.

That said, despite the long-term benefits of opening an ISA right now, there’s no denying that interest rates are currently pretty poor.

You’ll probably earn more by putting your money into a high-interest savings or current account – just bear in mind that you may have to pay tax on the interest, which in turn may count towards benefits, Maintenance Loan entitlement and Student Loan repayments.

How to open an ISA account

cat using laptop

Credit: Violet Giddings – Flickr

Setting up an ISA is actually pretty easy – in most cases, you can do it onlinein-store or by phone.

Different banks will have different policies on how exactly you go about setting one up, but usually you won’t need much more than your National Insurance Number, some ID and a proof of address. And if you’re setting up an ISA with your current bank, it’s likely you won’t even need that much.

Of course, you also need to make sure that you haven’t set up another cash ISA in the same tax year.

What to consider before opening a cash ISA

Here are some important questions to ask before you open a cash ISA:

  • What’s the interest rate, and does it include a temporary bonus?
  • Can you get a better deal by transferring an existing ISA (and are you allowed to transfer money in/out)?
  • Can you withdraw your money if you need it (i.e. is it an instant-access cash ISA)? Some accounts charge a notice period penalty, whereby you lose a certain number of days’ interest for withdrawing cash.
  • Some accounts will pay interest monthly/annually into your current account – handy for extra spending money!
  • Make sure the provider uses the Financial Services Compensation Scheme (FSCS) to protect your savings up to £85,000 (all the ones we’ve listed below are).
Try an automatic savings app or bot to save up some quick cash from your current account.

Best easy-access ISAs

If you want the benefits of tax-free interest, but also want the safety net of having access to your money when you need it, we’d recommend going with an easy-access account.

Just remember that the following interest rates are variable, meaning they could go up or down after you open the account.

Taking into account the interest rates and opening deposits, here are our top pick easy-access ISAs:

  1. Coventry Building Society Triple Access ISA (0.96%)

    coventry building society logo

    Open with: £1

    Interest paid: Monthly or annually

    Access: Open online, access online or in-branch

    Transfers in allowed? Yes

    Flexible? Yes

    Withdrawals: Maximum of three each year.

    Apply for this ISA »

  2. Principality Building Society Web ISA (0.8%)

    principality building society logo

    Open with: £1

    Interest paid: Annually

    Access: Open and access online

    Transfers in allowed? Yes

    Flexible? Yes

    Withdrawals: Unlimited

    Apply for this ISA »

  3. Al Rayan Bank Instant Access ISA (0.6% expected profit rate)

    al rayan bank

    Open with: £50

    Access: Open online or by post, access by post or via app

    Transfers in allowed? Yes

    Flexible? No

    Withdrawals: Unlimited

    Extra info: This ISA is Sharia-compliant, meaning it offers an ‘expected profit rate’ rather than a firm interest rate – hence it not ranking first. There are other ISAs with better interest rates (including some not featured here), but among easy-access Sharia-compliant cash ISAs, this is the best of the bunch.

    Apply for this ISA »

We’ve only listed ISAs that are available across the UK to all new customers. Some local building societies and banks may offer higher interest rates on their ISAs, but only to those who live in the area or to existing customers.

Best fixed-rate ISAs

You’ll often need a larger deposit to open a fixed-rate ISA, and you’ll be penalised for withdrawing money early – but, in return, you’ll usually get a better interest rate than an easy access ISA.

Fixed-rate ISAs with longer terms (i.e. when your money is locked away for longer) usually have better interest rates, so it’s a case of balancing how much you’d like a good interest rate against how soon you’ll want to cash out.

Here’s our pick of the top fixed-rate ISAs, taking into account the interest rate, minimum deposit and term:

  1. UBL UK Three-Year Fixed-Rate Cash ISA (1.1%)

    ubl uk logo

    Open with: £2,000

    Interest paid: Monthly, quarterly, annually or at maturity

    Access: Open by post, access online, by post or by phone

    Transfers in allowed? Yes (but only at application)

    Early withdrawal penalty: 270 days’ interest.

    Apply for this ISA »

  2. Yorkshire Building Society Two-Year Fixed-Rate e-ISA (0.9%)

    yorkshire building society logo

    Open with: £100

    Interest paid: Annually

    Access: Open and access online

    Transfers in allowed? Yes

    Early withdrawal penalty: 120 days’ interest.

    Apply for this ISA »

Use these money-saving resources to save some extra funds for your ISA.

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