PSA vs ISA – What’s the Difference?

Cash ISAs have never been less popular.

According to recent data from UK Finance[1], just £322m was invested in Cash ISAs in March, less than half of the £773m invested in March 2017.

And while this is largely due to the historically low interest rates being offered to savers, there may be another reason behind their waning popularity – the introduction of the Personal Savings Allowance, or PSA.

What is the PSA?

Introduced in April 2016, the PSA allows all basic-rate UK taxpayers to earn up to £1,000 in interest from their savings, completely tax free[2], while higher rate taxpayers can earn up to £500 per year in tax-free savings interest.

This allowance applies to all income from savings including bank, building society, and credit union accounts. It also includes interest earned from authorised unit trusts, open-ended investment companies and investment trusts, as well as annuity payments and income from bonds.

This covers just about any types of savings and investments in the UK, and if you manage your money accordingly, the allowance can go a long way.

The average Cash ISA pays just 0.7 per cent[3], which means that you would earn a total of £140 per year in interest if you invested your entire £20,000 ISA allowance.

In order to reach this £1,000 PSA limit, you would need to be earning five per cent per annum on a capital investment of £20,000 – a rate which is far beyond even the highest-paying savings accounts in the UK.

Which is better for savers – the PSA or the ISA?

With this in mind, the PSA appears to be more useful for conservative savers who wish to invest more than the annual ISA allowance of £20,000. There are a number of fixed-rate bonds and savings accounts which offer two per cent to savers, and PSA users can shelter up to £50,000 in these accounts without worrying about taxation.

And as an added advantage, if you are investing this money in a high street bank, up to £75,000 will be protected under the Financial Services Compensation Scheme (FSCS).

On top of this, a further £20,000 per year can be invested in a Cash ISA, Stocks and Shares ISA or an Innovative Finance ISA, with no tax paid on any of the interest accrued. In fact, the PSA may encourage some savers to take a few more risks with their ISA allowance in the hopes of getting higher returns.

But some experts have warned that Brits should not turn their backs on the ISA altogether. While the PSA offers more flexibility for tax-free savings, the ISA can deliver long-term benefits.

“With another interest rate rise on the horizon, people who rely on the PSA need to keep a close eye on their savings so they don’t get caught out,” said Andrew Lawson, chief product officer at peer-to-peer lending platform Zopa.

“Customers really could lose out if they use the PSA instead of the ISA, because the PSA is only tax free for one year while investments into the ISA are tax free for life. Of course, there are plenty of alternatives out there – such as the IFISA – which have higher returns than Cash ISAs and are covered by the tax-free wrapper but come with a bit more risk.”

[1] https://www.ukfinance.org.uk/household-finance-update-april-2018/

[2] https://www.gov.uk/government/publications/personal-savings-allowance-factsheet/personal-savings-allowance

[3] https://www.defaqto.com/media-centre/press-releases/cash-isa-rates-on-the-rise-for-the-first-time-in-seven-years-but-still-dont-offer-the-best-rates-according-to-defaqto/

Kathryn Gaw

Kathryn Gaw is a financial journalist based in Belfast, Northern Ireland. She has been writing about personal finance and investment trends for more than a decade, and her work has been featured in the Financial Times, City A.M., the Press Association, and The Irish Independent, among many other publications.