Why do Isas pay worse interest than other savings accounts?

It has always irked me that the interest rates offered by banks and building societies on cash Isas are usually about 1 percentage point lower than the rates for the same period they offer for “taxable” accounts.

For example, one of the banks that always ranks at the top of your best-buy savings interest charts — Charter Savings — currently offers 6 percent on its taxable one-year account, but only 5.2 percent on its one-year cash Isa. agreement.

What is their justification for this? It certainly can’t cost the bank much or nothing to maintain an Isa account instead of a traditional account. Via email.

Ed Magnus of This is Money replies: You are quite right to see the wide gap between the best taxable savings accounts and the cash Isa rates.

Currently, Charter Savings Bank offers both the market-leading one-year fixed taxable account that pays 6 percent, and the best one-year cash Isa that pays 5.2 percent.

Many of the banks at the top of our best buy savings charts have similar differences in their rates.

For example, Close Brothers Savings offers a one-year fixed-rate savings account that pays 5.85 percent, and a one-year cash Isa that pays 4.85 percent.

At £20,000, that’s the difference between earning £1,170 and £970 over the course of a year.

The gap may not have caused much frustration for savers in the era of floor rates.

But now that the best savings deals are generating meaningful returns, many more savers are at risk of exceeding their personal savings.

This means that the tax protection afforded by a cash Isa is all the more important – and as a result their appeal is increasing.

Savers paid £3.3bn to Isas in May, according to the latest figures from the Bank of England, making it a record year with the highest inflows in the month of May since the launch of Isas.

In total, savers have transferred £21.5 billion to Isas in the last three months alone.

We asked Anne Bowesthe founder of advice website Savings Champion, on why so many savings providers pay less on their Isa accounts than on their standard savings deals.

Anna Bowes replies: I agree that this is really frustrating behavior from many banks and building societies – and it hasn’t always been the case.

Before rates fell to all-time lows in 2012, providers were looking for depositors to raise the money they needed to fund their loans and were willing to pay for it — and they used the highly popular cash Isa as one of the ways to do this.

In April 2012, the best one-year fixed savings account paid 3.55 percent, while the best one-year Isa paid more at 3.6 percent.

Two-year fixes paid 3.90 percent versus 4.05 percent for Isas, and over three years it was 4 percent compared to 4.25 percent.

But the need to raise money from depositors diminished after the Financing for lending scheme was introduced, as a result of which competition in the savings market as a whole – and therefore also cash Isa rates – decreased.

The subsequent introduction of the Personal Savings Allowance in 2016 the death knell sounded again.

Most of the savers no longer had to deposit money into a tax-free Isa, because the interest they earned on their savings was already tax-free due to the allowance.

So the competition simply went out of business and as competition decreased, so did the rates offered.

There are also some additional administrative elements to an ISA that may be one of the reasons why rates are lower – such as the need to report to HMRC and unravel any duplicate ISAs that have been opened accidentally.

In addition, all money from Isas with a fixed term must give the customer access to the money within the term, albeit with a penalty.

This means that the provider cannot depend on that money, as with a fixed-term bond that gives no access at all.

Recent competition in the bond market has exacerbated the problem, as all providers seem to be focused on trying to pay the highest bond yields. Unfortunately, Isas are forgotten in battle.

But with rising interest rates, the personal allowance is now being used up with much smaller credits.

I think it’s time for Isas to become more competitive again, to help savers earn as much as possible.