Cash Individual Savings Accounts (ISAs) made a resurgence towards the end of last year as savers looked to shield their money from the taxman.

Paragon’s analysis of CACI data – an organisation that monitors the adult savings accounts of 34 providers - showed that fixed-rate ISA balances ended the year at £89.7 billion, up from £79.4 billion at the end of September 2022, and £74.5 billion at the same period in 2021.

The number of cash ISA deals on the market increased by 16% in the last year, according to analyst Moneyfacts.

Breaching the Personal Savings Allowance

A key driver of the resurgence in ISA saving is the Personal Savings Allowance (PSA). Basic rate taxpayers can earn £1,000 interest on their savings before incurring tax, with higher rate taxpayers benefitting from £500 PSA. Additional rate taxpayers don’t receive any PSA.

In a low-interest rate environment, only those with the largest savings balances were close to breaching their PSA, but as rates have risen more people are close to tipping over the threshold.

A higher rate taxpayer saving into a one-year non-ISA fixed-rate account at 4.00% would need a balance of £12,500 to earn £500 interest. Any balance above that would start to incur tax at the individual’s tax status. For example, if a higher rate taxpayer had £25,000 in the same 4.00% one-year account, they would earn £1,000 interest, £200 of which would be owed to the taxman – 40% of the £500 above their PSA.

Saving within an ISA wrapper protects those balances from the taxman. Savers can put £20,000 per tax year into a cash or stock and shares ISA, or a combination of both.

Income tax thresholds frozen

ISAs will be made even more attractive in the 2023/24 tax year as the Chancellor has made changes to individual income tax bands. From April 6, the rate at which individuals begin paying the additional rate of income tax at 45% starts at £125,140, down from £150,000.

The Government’s latest figures show there are 629,000 additional rate taxpayers and 5.5 million people in the higher rate bracket, but this change will swell the number of additional rate payers.

Additionally, the Government has also frozen the personal allowance, and the basic and higher rate income tax thresholds in England and Northern Ireland until April 2028. As salaries rise, this will likely drag more people into the higher rate band over this period.

Consultancy LCP said HMRC data suggested frozen thresholds alone had dragged an extra 125,000 people into paying tax on their savings. When interest rate rises are factored in, the number of people expected to pay tax on their savings is set to rise from 1.4 million in 2016 to approximately 2.4 million in 2023.

Tax timing is key

A further factor for savers to consider is the fact that the tax due on savings is determined by the year that the savings interest becomes available to the saver – your PSA doesn’t rollover. If the higher rate saver with a balance of £12,500 placed the money in a five-year 4.00% non-ISA account which didn’t enable interest to be paid away during the term, the individual would earn £2,708.16 interest on maturity, approximately £883 of which would be due to the taxman.

Although ISA rates can be slightly lower than non-ISA cash rates, the tax benefit often makes them a more attractive proposition. Using the above example in a 3.85% five-year cash ISA, the individual would earn £2,598.80 interest tax free on maturity, resulting in £773 more than the higher 4.00% non-ISA.

Derek Sprawling, Paragon Bank Savings Director, said: “Although ISAs have always been high on our agenda, ISAs were out of favour with some savers for a while, but people are seeing the benefit of the tax-free wrapper as rates have risen and the Government freezes income tax thresholds whilst lowering the additional rate threshold.

“Additionally, the rate differential between ISA and non-ISA accounts has narrowed in recent months, again a factor that has added to the popularity of the ISA wrapper.”