How to ensure you make the most of your ISAs

Millions of us have ISAs – the savings accounts that pay interest tax-free – but how do ensure you're making the most of it?

Individual savings accounts (ISAs) let you earn interest on your money tax-free as long as you leave it in the account. It’s an incentive that means 15 million people put money in ISAs in 2012, with more than £50 billion stashed in them.

Yet a survey from MoneySupermarket found that 34% of visitors to its site said they hadn’t taken advantage of their ISA allowance this year, with more than 8% saying they wouldn’t bother.

Worryingly, that means millions could be missing out, as rates have plummeted in recent years and savings could be earning as little as 0.25% a year. While the days of 6% returns might be long gone, you can still earn more than 3% interest on the top deals.

So to help people make sure they get the most they can, I’ve put together an easy-to-follow guide to making the most of your ISA.

[Free guide: Where to invest your ISA in 2013]

Finding the best ISA account

Cash ISAs are as simple to use as standard savings accounts, but you need to make sure you’re using the right one for you.

For example, if your ISA is also your emergency fund then you’ll need to be able to get at the money in a hurry. Locking it away in a fixed-rate bond or other restricted access account probably isn’t the best thing to do, so an easy access ISA should be your first port of call.

But savers with larger ISA balances they want to transfer can get a better rate by looking at locking their money away for up to five years.

As a general rule, the more restrictions you can accept, the higher a rate you can earn – although you’re taking a gamble that average rates won’t rise during the period and make your account less competitive.

You can often get better rates using an online account – so if you’re happy to not have branch access or the ability to withdraw money from a cashpoint then go for one of these.

Find the top-paying ISA account

It’s not just about finding the right kind of account; you’ll want to find the highest rate going. With inflation so high, you risk the value of your savings being eaten away but you can cushion yourself against this with a competitive cash ISA.

For example, some easy access accounts are paying 2.5%, while others are offering just 0.1%. If you’re prepared to lock your money away, you can get rates of as much as 3.1%.

That shows that you can’t just take whatever account your bank is offering; it’s essential to go online and compare rates to find the best one.

Check your rate and MOVE

When you first opened your ISA, it was probably paying a competitive rate. But that won’t necessarily have lasted, particularly as many are boosted by a short-lived ‘bonus’ rate.

That’s why it’s so important to keep track of the rate your ISA is paying, and to switch if it starts to look uncompetitive.

For example, the Santander Flexible ISA Issue 4 paid 2.81% for new balances but that falls to just 0.5% once the bonus runs out. If you transferred a full year’s ISA balance of £5,640 to an account paying 2% you’d make £84.60 more over a year. That’s hardly peanuts.

Some rates are falling as low as 0.25%, that’s even less than base rate. Don’t let apathy wipe out your tax-free savings.

So how do you move then?

If you’ve got more than £5,640 to move (ie this year’s allowance), you need to ensure the ISA you’re moving to “accepts transfers in”.

While you can only open one ISA a year, transferring cash doesn’t count as opening a new ISA. So once you’ve found the right deal for you, round up all of your legacy accounts and move to the best deal you can find.

To do this you may need to speak to your existing ISA provider to arrange the transfer and fill out an ISA transfer form. Simply withdrawing the cash or closing the account means your savings lose their tax-free protection and you could only pay £5,640 of it into the new account.

Some providers will contact your old provider for you if you supply them with the details.

But be careful, if you’re on a fixed-term deal (ie one that offered a fixed interest rate for four years) then you could be hit with penalties for withdrawing the money early. So check your terms and conditions before transferring any money.

ISA providers should move your existing cash to a new ISA within 15 days.

Save something… Anything

You’re allowed to save up to £5,640 in cash this tax year and if you don’t do so in time then you lose that allowance. So it’s worth trying to save something, even if you can’t manage the full amount.

If you could only afford to save £10 a month throughout the year, you’ll still have £120 of savings that the taxman can’t touch until you take it out of the account.

Remember, the earlier in the tax year that you pay the money in, the more tax-free interest you’ll make.

Keep the taxman out of your kids’ cash too

It’s not just your money the taxman wants his share of, your kids’ savings need protecting too. By saving their money into a Junior ISA (which is what they get now instead of Child Trust Funds), children can avoid paying tax on their money until they are 18 and even beyond.

You can save up to £3,600 a year into a Junior ISA and when they turn 18 the account automatically becomes an adult ISA, so their nest egg stays protected from the taxman.

Junior ISAs aren’t right for everyone; the money is locked away until the child turns 18. Also, the vast majority of children don’t actually pay tax.

A junior ISA could be right for your child if you’re saving a substantial amount or if you want them to enter adult life with tax-free savings already in place.

You also need to remember that it’s your child’s money once you pay it in. If they choose to blow it when they reach 18 then there’s nothing you can do.

If your child was born between September 2002 and January 2011 then they can’t qualify for a JISA as they’ll have Child Trust Funds instead.

Are you saving into an ISA? Is it worth saving when inflation is so high? Share your thoughts with other readers using the comments below.