While some will have been rewarded for adopting a more proactive approach to cash management, any funds left dormant will have generated interest at a level probably best described as lower-than-hoped-for.
After a series of rises in the Official Bank Rate, however, cash has taken on an altogether different perspective. Today, many people in the UK who have built up reserves find themselves in the unexpected and unfamiliar situation where they can potentially generate more generous returns from cash than they have been able to in the recent past. For these savers, interest just got a lot more interesting.
Momentum swings behind savers
It has been a rapid transition. Interest rates first fell below 1.00% in March 2009 in the wake of the financial crash, and they remained below that level for more than thirteen years. After they finally breached the 1.00% threshold again in June 2022, it only then took around thirteen months for them to climb to the current level of 5.25%.
Savers have been further encouraged by the newly introduced Consumer Duty and its enforcement by industry regulator the Financial Conduct Authority (FCA). These rules have placed the onus on lenders to ensure the Bank Rate increases instituted by the Bank of England are reflected in the interest rates that consumers are seeing applied to savings products.
Indeed, the FCA has unveiled a 14-point action plan for cash savings, which sets out a series of demands and expectations on lenders. It promises to take “robust action” against firms offering the lowest rates where they are unable to demonstrate “fair value”.
As rates for savings products have improved, consumers have responded. According to one study, the majority of savers (59%) are shopping around in order to secure the best possible rates on savings accounts. As many as half (50%) have already taken action, moving an average of £17,360 from their cash reserves, while two in five (39%) say they plan to move an average of £18,608 in the next six months.
These findings are reinforced by separate research showing that more money has been moved into cash ISAs (Individual Savings Accounts) in the first three months of the 2023/24 tax year than at any time since ISAs were launched more than two decades ago. This equates to more than £9 billion.
Taking tax into account
One of the major factors driving this trend is the fact that ISAs are highly tax efficient. Every year, individuals can pay up to £20,000 into an ISA – whether a cash ISA, a stocks and shares ISA or a combination of both – and any interest and dividends are free from income tax, while profits from investment growth are free of Capital Gains Tax.
While ISA savers are therefore able to benefit from holding cash in a tax-efficient wrapper, increasing numbers of others are facing the prospect of paying tax on cash interest. This applies when interest earned from savings exceeds a certain level, known as the Personal Savings Allowance.
The Personal Savings Allowance varies according to your income tax band. For basic-rate taxpayers this is set at £1,000, with any interest earnings over this allowance taxed at 20%. Higher-rate taxpayers are taxed at 40% for interest earned over their allowance level of £500.
The Personal Savings Allowance does not apply to additional-rate taxpayers, meaning any interest earned on savings is charged at 45% unless, for example, cash is held in an ISA.
Key considerations
While these thresholds have remained fixed since 2016, recent increases to interest rates are expected to pull more savers into the scope of a possible charge. Estimates suggest this situation will apply to more than 2.7 million people in the UK in the current tax year, which would represent an increase of almost one million people.
At the other end of the spectrum, there are warnings that some older savers could be missing out on valuable interest income every year by keeping their cash in accounts with rates of 3% or lower. Research indicates this could apply to more than half of retirees, despite the fact that a large proportion (42%) could generate improved returns from their substantial cash savings.
It can be seen, therefore, that rising rates present interesting new opportunities to make your cash work harder, and this can be particularly valuable while inflation continues to erode the value of money in real terms.
Equally, this situation can mean you are at increased risk of incurring an unexpected tax charge, underlining the importance of keeping a close eye on your cash savings at a time of change and adopting an approach that fits with your wider financial plans and ambitions.
The information contained within this communication does not constitute financial advice and is provided for general information purposes only. No warranty, whether express or implied is given in relation to such information. Broad Street Financial Planning or any of its associated representatives shall not be liable for any technical, editorial, typographical or other errors or omissions within the content of this communication.