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Cash ISA rates improve but still lag savings accounts

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Competition in the cash ISA market has stepped up since the start of the year, with 24 banks and building societies increasing rates or launching new products, according to research.

The highest easy access ISA rate is 1.45% from Virgin Money, which is a vast improvement on the top rate of 1.21% available a year ago from the same provider, data from Moneyfacts shows.

Shawbrook Bank, Yorkshire Building Society and Tesco Bank have also upped their rates and feature in the top 10 best deals, paying 1.43%, 1.41% and 1.38% respectively.

Rates on fixed-term ISAs have also improved since the beginning of the year. Cynergy Bank currently pays a table-topping 1.73% on its one-year fixed ISA, a significant increase on the 1.45% best buy 12 months ago from Leeds Building Society.

On a two-year fixed ISA, the best rate available is 1.9% from Coventry Building Society, while a year ago, the best rate was 1.7% from Al Rayan Bank.

But despite the renewed competition, non-ISA fixed rate bonds and easy accounts still pay better returns.

The best easy access rate outside of an ISA wrapper is 1.54% from ICICI Bank UK, while the best one-year bond comes from Al Rayan, an Islamic bank, offering an expected profit rate of 2.15%.

Rachel Springall, finance expert at Moneyfacts, said: “In real terms, many of the cash ISAs available on the market fail to outpace the impact of inflation. In fact, only three deals can beat 2.1%, the current level of inflation.”

Why have ISA rates been so poor?

The introduction of the Personal Savings Allowance (PSA) in April 2016 had a “devastating impact” on the ISA market, according to Springall.

The rule allows basic rate taxpayers to earn up to £1,000 in savings income tax-free or £500 for a higher rate tax payer.

As tax-free saving was one of the key benefits of the cash ISA, their appeal declined with the arrival of the PSA and so too did the rates on offer.

The influx of challenger banks has also played a part, with these providers mainly launching non-ISA products.

ISAs v savings accounts

The PSA means most people no longer pay any tax on their savings so for them, the best rate should be their main consideration.

At the moment, rates are better on non-ISA deals, but the situation could change, especially if competition among ISA providers continues to heat up.

For some people, however, a cash ISA could be a better option. Additional rate taxpayers (45%) who earn above £150,000 are not eligible for a PSA but they can still save tax free in an ISA.

Also, people with big savings pots who go over their PSA threshold can save into an ISA tax-free (cash ISAs do not count towards your PSA, they can be held in addition).

It’s also worth noting that the PSA is not guaranteed to be around forever, and if interest rates start to increase, savers could soon start to breach their £1,000 or £500 PSA limit.

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