14:29 13 March 2013
If you'd invested your full ISA allowance each year since the accounts were first launched back in April 1999, you'd have amassed £18,592 in interest alone, according to our analysis at MoneySupermarket.
This is £4,383 more than if you had invested the same amount into an average-paying easy access savings account over the same timeframe. The moral of the story? To be sure to make your tax-free ISA allowance your first port of call.
But, even if you've let ISAs pass you by until now, the good news is it's never too late to start. For the uninitiated, here's a look at how ISAs work, and why you shouldn't so much as look at an easy access account until you've first invested your full ISA allowance first.
What's an ISA?
An ISA (Individual Savings Account) comes with special tax privileges. If you invest in a cash ISA you won't pay income tax on the interest you earn and if you invest in a stocks and shares ISA, you won't pay capital gains tax on your returns either.
ISAs were first introduced in April 1999, and were designed by the government to encourage us to save over the long-term.
Every UK resident who is 16 or over has an annual ISA allowance, which dictates how much money you can shelter from tax. In the current tax year it's £11,280, of which up to half (£5,640) can be held in cash and the other half in a stocks and shares ISA. Alternatively, you can invest the whole £11,280 in stocks and shares.
As of April 6 this year, this allowance will go up to £11,520 - but the same rules will apply on splitting it between a cash ISA and a stocks and shares ISA. This means up to £5,760 can be held in cash.
This two minute video does a quick run-down of everything you need to know
How's that different to an easy access savings account?
When you put your money in a standard savings account like an easy access savings account, your returns are taxed.
Let's say you invested the same amount as your ISA allowance (£11,280) in an easy access account - here's how it would break down:
If you're a standard rate taxpayer you'll pay 20% tax on the interest you earn. If you're a 40% or 50% taxpayer, you'll have to declare any interest earned from savings on your tax return and pay any additional tax due.
If you're a basic rate taxpayer and put your £11,280 in a standard savings account with an annual equivalent rate (AER) of 1.55%, you'd earn £175 in interest over 12 months, but 20% of that would be taken in tax, leaving you with £140.
If you'd invested the same amount in a cash ISA with the same rate, you'd get the full £175, because ISA returns are not taxed.
Look at it this way - an easy access account paying 1.55% actually translates to 1.24% for a basic rate taxpayer, once you factor in how much will be taken in tax.
A cash ISA with a rate of 1.55%, however, is exactly that - aside from any temporary bonuses (usually lasting for 12 months), which also apply to some standard savings accounts anyway.
What's more, ISA rates tend to be more attractive than easy access rates to begin with.
For the time being, Halifax's two-year fixed rate ISA tops the ISA tables with its 2.50% rate. Also, if you have £5,000 in this or any Halifax savings account, you'll be entered into a prize draw to win up to £250,000.
The draw will offer three top prizes of £250,000 and ten prizes of £5,000 in May. Each month, Halifax will also give away 100 prizes of £1,000 and 1,000 prizes of £100.
To stand a chance of winning, customers must hold at least £5,000 in a qualifying account for the whole of the month prior to a draw (starting with April).
The Barclays Bank Instant Cash ISA Issue 1 pays 2.30% (including a 0.80% bonus for 12 months), though on minimum balances of £30,000.
By comparison, the top-paying account over on our easy access accounts channel, the Halifax Online saver, pays an AER of 1.55% for balances of more than £1 and under £20,000.
Even the NatWest e-ISA, which has no rate-inflating bonus, beats the best easy access accounts on the market, with tiered rates starting at 1.75% on balances below £30,000. And you only need £1 to open that one.
So if you're going to stash some cash away in a savings account, using your full ISA allowance first is a bit of a no-brainer. While returns tend to be higher on fixed rate ISAs, there are easy access ISA deals available too, which - just like an easy access savings account - mean you can get your hands on your money immediately. Bear in mind though, you only get one chance to use your allowance each year, so if you withdraw any, you won't be able to pay it back in and claim the tax-free benefits.
Following our findings that the average saver would be £4,383 richer by opting for ISAs over easy access accounts, our head of banking, Kevin Mountford, said:
"ISAs should be a number one consideration for UK taxpayers who want to make the most of the tax-free benefits on offer. If you have savings and pay tax and don't use your full allowance, you are throwing money at the taxman, which is not something any of us like to do."
MoneySupermarket research found that nearly four-in-10 (39%) of people plan to save (or have saved) in a cash ISA this year, but only 28% of cash ISA savers plan to use their full allowance. It's not too late to do something about this though - you have until April 5 to use your 2012/2013 allowance or lose it for good.
If you want to learn more about ISAs, visit our Great Big ISA Event page here.
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