How to use an Isa to save tax-free as they celebrate their 20th birthday

British savers have sheltered a huge £35 billion from the taxman in the 20 years since the Isa was launched, Money Mail can reveal today.

Individual Savings Accounts – or Isas – have been handing out tax-free rewards for two decades. 

They now help us to invest, buy our first homes and save for our retirement and our children’s futures.

Today, in our 20th anniversary special, we can reveal that banks and building societies have finally started to boost rates on their cash Isas in the run-up to the end of the tax year next month.

Happy birthday: Isas have been handing out tax-free rewards for two decades. They now help us to invest, buy our first homes and save for our retirement and our children's futures Perk: The Government sets a limit for how much money you can put into your Isa each tax year Any interest earned on this money is entirely tax-free Investment: David Charles

Cash Isas alone now hold £280 billion — handing out £2.5 billion in tax-free interest every year, based on the average rate paid out by banks and building societies at 0.9 per cent.

The top rate on both easy?access taxable accounts and non-taxable cash Isas is 1.5 per cent, with big player Santander offering the cash Isa version. The last time cash Isa rates reached this level was in March 2016.

The gap between one-year fixed-rate accounts has also narrowed, though not yet disappeared.

The best one-year fixed-rate cash Isa, with Shawbrook Bank, now pays 1.77 per cent, while the top fixed-rate bond is Shawbrook’s at 1.97 per cent — a 0.2 percentage point difference. This time last year, the gap was double the size at 0.44 points, or 1.46 per cent and 1.9 per cent respectively.

How to profit from an Isa 

On this podcast, we talk all things Isas: whether they are worth it, the options and importantly, are the new top rates a potential catalyst for more competition?

Press play above or listen (and please subscribe if you like the podcast) at Apple Podcasts, Acast, Spotify and Audioboom or visit our This is Money Podcast page.  

An Isa is still worth it, despite the savings allowance

Cash Isas lost their sparkle three years ago with the arrival of the personal savings allowance after years of rock-bottom interest rates.

The personal allowance lets a basic-rate taxpayer earn up to £1,000 a year in savings income tax-free. Higher-rate taxpayers can earn up to £500. 

So savers could earn higher rates and still pay no tax simply by opening an ordinary savings account, rather than a cash Isa.

In the year before the arrival of the personal savings allowance in 2016, 10.1 million savers rushed to open a cash Isa, putting in an average of £5,801. 

In the last tax year, this tumbled to 7.8 million putting in an average of £5,114. Despite the fall, they remain by far the most popular Isa type — with their nearest rival, the stocks and shares Isa, clocking up 2.8 million accounts in the last tax year.

Savers have until April 5, the end of the tax year, to use their £20,000 cash Isa allowance for this tax year and earn tax-free interest on their money.

On April 6, your cash Isa allowance will be renewed for another 12 months and you will then be able to save another £20,000.

With a rate of 1.5 per cent, you can have savings of £66,000 in a taxable account and earn £990 in interest tax-free as a basic-rate taxpayer. However, at 2.5 per cent, tax would start to bite once you have saved around £40,000.

With a cash Isa, on the other hand, you are protected if your savings grow or interest rates rise. 

Experts say it is a good idea to use cash Isas even if you don’t bust your personal savings allowance. There is no guarantee the latter will last, as it could be cut in future years by any government.

Cash Isas, on the other hand, are more likely to remain untouched.

There is a tiny gap of around 0.05 percentage points among the very top payers with accounts on offer now, which translates into just £10 interest a year on the full £20,000.