5 hidden pitfalls of cash to avoid as savings rates rise

According to Moneyfacts (as of 11 September 2023), the best easy access cash savings rate is currently 5.2%. A one-year fixed-rate bond, meanwhile, could pay as much as 6.1%.

After years of poor rates for cash savers, you might be considering saving more – and maybe even pulling money out of your investments.

We recently wrote about why now isn’t the time to ditch your long-term investments despite rising cash rates and outlined several key reasons why we’ve taken that stance. These included the opportunity cost of lost time in the markets and the effects of high inflation on cash savings.

There are other potential pitfalls to cash savings too and some key factors to consider.

Here are five of them.

1. You might have to pay tax on the interest you earn

While your Cash ISA savings are free of both Income Tax and Capital Gains Tax (CGT), the interest you earn on your cash holdings in non-ISA savings accounts could become liable for Income Tax.

The tax applies when interest exceeds a limit known as your “Personal Savings Allowance”, which is based on the rate of Income Tax you pay.

Source: HMRC

While interest rates have been poor over the last decade or so, rising rates now mean that you’ll need to think carefully about the value of your cash holdings, the interest you might accrue, and any tax liability that arises.

It’s worth noting that your Personal Allowance can be used for interest if your income for the year has not exceeded it. This could provide you with a starting rate for savings but tax on interest might still apply.

Speak to us if you think your savings interest could become taxable.

2. You might be liable for Capital Gains Tax when disinvesting into cash

As we have already seen, gains made in an ISA are free of CGT, but you could become liable for the tax when moving funds held outside of a wrapper.

While it is true that some gains are exempt, the annual exempt amount for CGT has more than halved for 2023/24, compared to the previous tax year.

The exempt amount has dropped from £12,300 to just £6,000 and will halve again from April 2024 to £3,000.

This severely limits the gains you can make without becoming liable for CGT.

If you intend to disinvest funds you’ll need to think very carefully about how much you withdraw and when. Be aware, too, that the unused exempt amounts cannot be carried forward.

3. Switching and disinvesting can lead to administrative headaches

As well as the tax implications of moving cash, you’ll have logistical issues to consider.

With rates changing frequently, you’ll need to keep on top of the best deals and then be sure you have everything in place – from ID requirements to easily accessible funds – when the time is right.

You might also find that you need to file your own tax return, which is another hassle, or an added expense if you choose to outsource the task.

4. You’re only protected up to £85,000 so may need to “split” your wealth

Money held in cash is protected by the Financial Services Compensation Scheme (FSCS). But this independent, government-founded organisation can only protect your funds up to certain limits.

If the bank or building society holding your money fails, the FSCS can protect up to £85,000 of the money held in that account. Holding more than that amount with one provider means that you might not get all of your money back if the institution fails.

To ensure that the whole of your cash savings are safe, it might be necessary to split your funds across multiple institutions, leaving no more than £85,000 in each.

This approach has its own pitfalls though. Not only will you have the administration stress of splitting and transferring funds, but you’ll also need to be very careful about the institutions you choose.

Some umbrella organisations can own multiple high street banks. Research your choices carefully to make sure that your split is genuinely between unrelated organisations. Failing to do so could mean your money isn’t protected.

5. Be sure that your decision isn’t an emotional, knee-jerk reaction

The final pitfall of cash could well be the opportunity cost of missed investment returns.

While it’s natural to get nervous about your investments during periods of economic uncertainty, staying focused on your long-term goals is likely to be a sensible course of action.

Ditching your investments when times are tough means your money won’t be invested when the markets recover. Remember the old investment adage, “it’s time in the market, not timing the markets that counts”, and read why now isn’t the time to ditch your long-term investments despite rising cash rates for more information.

Get in touch

If you would like to discuss your current savings and investments, or you need reassurance, we’re on hand to help so get in touch.

Please contact us on info@janesmithfinancial.com or call 01234 713131.

Please note

This blog is for general information only and does not constitute advice. It should not be seen as a substitute for financial advice as everyone’s situation is different.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

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