ISA interest: is monthly or annual better?

Do ISAs pay interest monthly or annually?

It depends on the account. Some Cash ISAs pay interest monthly, some pay it once a year, and many let you choose between the two. The terms of your account say which options you have and when the payments are made.

Fixed rate ISAs can also pay monthly interest, so a fixed rate does not rule out taking income. Whether a fixed rate ISA pays monthly, annually or gives you the choice depends on the product.

Monthly or annual ISA interest, at a glance

Tax on interest inside a Cash ISA

None

Paid monthly or annually

The number to compare

AER

Annual equivalent rate

£10,000 at 4.00% AER, interest left in the ISA

£400

A year of interest, monthly or annual. Illustration, not a forecast

Same example, monthly interest paid out

About £393

The paid-out interest stops compounding

Why is the monthly ISA rate lower?

Because monthly interest is paid 12 times a year, and each payment can start earning interest itself. To end the year in the same place as one payment of annual interest, the monthly rate has to be a little lower.

The AER, or annual equivalent rate, puts the two on one scale. It shows what the rate would be if the interest were paid and added to the account once a year. UK Finance and the Building Societies Association describe it as a notional rate, and it is the one rate that can be compared across accounts however often they pay. Their guidance says a Cash ISA rate should be shown as the AER alongside a tax-free rate, which is the stated yearly rate before compounding.

If the AER is the same for both options, the monthly rate is the lower number. If the AERs differ, the option with the higher AER earns more over a year when the interest stays in the ISA, so the AER on each option is the one to read.

A worked example at 4.00% AER

This is an illustration, not a forecast, and it is not tied to any account. The 4.00% is a round number chosen for the example, not a rate on offer. It assumes £10,000 in a Cash ISA for 12 months, with no change to the rate and no bonus. Yearly totals are rounded to the nearest pound.

To get the monthly figure, take the twelfth root of 1.04, which is 1.003274. That is a monthly rate of 0.3274%, or 3.93% a year when you multiply it by 12. Compounded for 12 months, it grows £10,000 to £10,400, which is the 4.00% AER.

In the last row the interest is paid out each month and does not compound. You receive about £32.74 a month, which is about £393 over the year and roughly £7 less than in the other two rows. UK Finance and the Building Societies Association’s note says that if interest is not paid into the account and compounded, the AER will not be achieved.

That gap is not a loss as such. The AER assumes the interest keeps earning the same rate. If each monthly payment were put to work at that same rate, you would end up in the same place, but outside an ISA the interest it earned could be taxable.

Who is monthly interest for?

Monthly interest suits people who want to take the interest as regular income. Annual interest suits people who do not need income during the year and are happy with one payment. If you leave the interest in the ISA, the two earn the same over a year when the AERs match.

Two things are worth checking in the terms. First, whether monthly interest is added to your ISA balance or paid out to another account, because that decides whether it keeps compounding. Second, whether the monthly option has conditions of its own, such as a minimum deposit.

Rates change often, so this page quotes none. Our Cash ISA rate tables show the AER of each account.

What if interest is paid out of the ISA?

You can take interest out of an ISA, but the money is then outside the ISA. gov.uk says you can take your money out of an ISA at any time without losing tax benefits, and to check the terms for any rules or charges. It also says you keep your savings on a tax-free basis for as long as the money stays in your ISA. So the interest was earned tax-free, but interest that the paid-out money earns elsewhere can be taxable above your allowances. See Do you pay tax on ISA interest?.

Paying it back in is a new payment into the ISA. It uses your allowance, unless your ISA is flexible and you replace the money in the same tax year. HMRC’s guidance says income paid away from a flexible ISA counts as a withdrawal that can be replaced without using allowance. If your ISA is not flexible, taking money out does not give you the allowance back. See flexible ISAs.

Interest that stays in the ISA does not use any of your £20,000 allowance. Only money you pay in counts. See the ISA allowance.

When is ISA interest paid?

The terms of the account set the dates. Monthly interest is paid every month. Annual interest is paid once a year, on a date the terms give. Some accounts pay at longer intervals, such as at the end of a fixed term.

UK Finance and the Building Societies Association’s advertising guidance says an advertisement that quotes a rate of interest must also say how often the interest is paid, for example monthly, annually or after five years. The note is for guidance only, so check the terms of the account you are looking at.