What is an Individual Savings Account (ISA)?
Individual savings accounts are denoted by the letters. While the name is fancy, the premise is straightforward: it’s merely a tax-free savings or investing account. Each tax year, you are given an ISA allowance, which determines how much you can save in a tax-free account.
How much money can I put into an ISA?
The maximum amount you can save in an ISA for the current tax year (2021/22) is £20,000.
You have the option of investing the entire amount in one form of ISA or splitting it between several types. Even if you chose to split it, you can’t invest more than £20,000 total across the various varieties.
To count towards that year’s allowance, you must save or invest before 5 April, the end of the tax year. Importantly, any unused allotment does not roll over, so if you don’t utilise it, you will lose it permanently. When the new tax year begins on April 6, you’ll receive a new allowance, but you won’t be able to contribute to the old ISA.
Any savings or investments that remain in the tax-free ISA wrapper will continue to generate interest (or experience investment growth/loss) and benefit from the tax advantages until you release the funds.
What are the different kinds of ISAs?
We’ve put up a fast table to provide you an overview of the five ISA types, who they’re for, and how they compare, as some have varying maximum allowances and some allow you to save safely while others put your money at risk.
The five main types of ISAs:
This section outlines the key characteristics of each of the five types of ISAs before directing you to our more detailed tutorials. To skip to the section you’re most interested in, scroll down or use these links:
- Stocks & Shares ISAs
- Cash ISAs
- Junior ISAs
- Innovative Finance ISAs
- Lifetime ISAs
Cash ISAs are risk-free and tax-free savings accounts.
If you have a lot of money in a savings account, you may have to pay tax on the interest if you go over your personal savings allowance (£1,000 for basic-rate taxpayers, £500 for higher-rate taxpayers).
However, interest earned on a cash ISA is never taxed. Plus, any interest you make in a cash ISA does not go against your personal savings allowance, so if you’ll be earning a lot of interest, you may put it in an ISA to safeguard more of it.
Cash ISAs come in a range of shapes and sizes, much like regular savings accounts…
- Cash ISAs with easy access. These do exactly what they say on the tin: you put your money in and can access it whenever you want, with no fees.
- Take note of cash ISAs. To withdraw your money, you must offer a specific number of days’ notice. They’re ideal if you require immediate access but can wait for your money.
- Cash ISAs with a fixed rate of interest. Fixes normally have greater rates than easy-access or notice ISAs, but you’ll likely have to pay an interest penalty if you need to access your money.
- ISA Purchase Assistance (no longer available to new applicants). These ISAs were created to assist first-time purchasers by providing a 25% bonus (up to £3,000) from the government. See Top ISA Buying Assistance for more information.
Is it worthwhile to invest in a cash ISA?
The personal savings allowance (PSA) ensures that all savings are tax-free. Basic 20 percent rate taxpayers can earn up to £1,000 in interest per year without paying tax on it, whereas higher 40 percent rate taxpayers can earn up to £500 per year without paying tax on it (top 45 percent taxpayers will always pay tax on savings).
Most people will be able to make all of their savings tax-free with that amount, thus the question is simply “what pays the greatest rate?”
The answer isn’t necessarily cash ISAs; when comparing regular savings versus ISAs, saves frequently pay out more. However, there are a few circ*mstances in which a cash ISA is worthwhile, particularly for people with significant resources. See our Cash ISA guide for more information.
In a cash ISA, you can save up to £85,000 per person, per financial institution.
The savings protection for cash ISAs is the same as it is for regular saves. So long as your money is in a UK-regulated bank or building society account, the Financial Services Compensation Scheme will cover £85,000 of it.
Shares and stocks ISAs
Shares and stocks ISAs are tax-free investments, but keep an eye out for fees.
You can also invest with your ISA allotment. A stocks & shares ISA is a form of account in which you can invest in funds (a collection of shares or bonds from multiple companies combined into one investment), bonds (essentially a loan to a company or government), and individual company shares.
Remember that investing entails risk, as the value of your investments can go up or down depending on how well your funds, bonds, and shares perform. The prevailing view is that investing is a long-term game, and that you should save money for at least five years to balance out any ups and downs.
Fees for trading. This is the price you pay each time you purchase or sell stocks or mutual funds. These might range in price from zero to twenty-five pounds. If you’re a frequent trader, finding a minimal trading fee should be a top consideration.
Fee for transferring out. The cost of switching your stocks and shares ISA from one platform (provider) to another, which is often between £25 and £50, however some systems do not.
When you first start saving in a stocks and shares ISA, you may not see any benefits above simply investing your money through one of these platforms without opening an ISA, as you already have different tax-free allowances around investing.
However, if you plan to add to your investment over time, it’s advisable to do so in a stocks and shares ISA because the ISA wrapper’s protection is permanent. The following are some of the benefits of a stocks and shares ISA versus a non-ISA investment account:
Tax exemption on capital gains (CGT): This is a profit-based tax that you only have to pay when you sell your investments. Everyone gets a pretty generous £12,300 annual allowance, which means they can make this much profit from shares, stocks, or property each year before being taxed.
However, if you’ve been investing for a long time and have huge holdings of stocks or mutual funds that you sell for a large profit, this could have an impact on you. This is why it’s a good idea to start (and keep) investing in stocks and shares ISA.
Bond interest is exempt from taxation: A stocks and shares ISA will protect the interest you earn from the taxman if you invest in bonds.
Dividend income is exempt from taxation: Dividends earned in an ISA are tax-free, whether you earn £1 or £10,000. You only get a £2,000 dividend income limit per year if you don’t have an ISA; if you earn more than that, you’ll have to pay tax.
Again, going over your dividend allowance is unlikely when you first start investing, but it could be a problem if you’ve added to your portfolio over time.
If you invest in a stocks and shares ISA, your savings are not safeguarded from losses.
If you put money into a stocks and shares ISA and subsequently invest it in funds, shares, or bonds, you are making a ‘risk-based investment,’ not a savings account. As a result, if the investments you make don’t work out, you could lose money – possibly all of it. If this happens, there is no way to defend yourself.
However, the Financial Services Compensation Scheme provides some protection, but only if you lose money as a result of the investment’s product provider going bankrupt – for example, if you have a stocks and shares ISA with a bank and the bank goes bankrupt.
However, if you’re buying shares or funds through a provider, the fact that the provider went bankrupt wouldn’t necessarily matter. For example, some providers would simply offer you shares or funds without owning the funds. There would be no compensation because you would still own the shares or be invested in the funds.
Lifetime ISAs
Lifetime ISAs provide you a 25% bonus if you’re saving towards a first home or retirement.
In 2017, Lifetime ISAs were introduced to assist people in saving for their first house or retirement.
However, they’re a bit of an outlier in the ISA world, as you can only invest £4,000 every tax year. So, whereas you can put the entire £20,000 allocation into a cash ISA, a stocks & shares ISA, or an innovative finance ISA, you can only put £4,000 into this one. Lifetime ISAs are divided into two categories:
- Cash ISAs are a type of ISA that allows you to save money for the rest of If you’re saving for your first house and plan to buy within the next couple of years, this may be the preferable option because you’ll know exactly how much money you have and your funds will be safe.
- Shares and stocks ISA for the rest of your life. When it comes to investing, you should always think long term to give yourself enough time to ride out any stock market downturns. So, if you’re saving for retirement or if buying your first house is a long way off and you’re willing to take some risk with your money in the meanwhile, this may be the best option.
You can either save the £4,000 as a big sum or as much cash as you can. The state will then add a 25% incentive on top of that for each month you save something. So if you save £1,000, you’ll end up with £1,250, and if you save the whole £4,000 per year, you’ll end up with $5,000 thanks to the bonus. That’s before you factor in interest or investment growth. The most important things you should know…
You can only open one if you’re between the ages of 18 and 39. You can pay in till you’re 50 after you are 40, but you won’t be able to start a new account (except to transfer).
You can hold one or more of the other forms of ISA in this guide if you’ve saved the maximum £4,000 in a Lifetime ISA in any tax year and have spare cash left over to save – but keep in mind that your allowance for those will be capped at £16,000 in the same tax year.
A cash LISA keeps your money secure, but a stocks and shares LISA puts it at risk.
Your savings are protected the same way they would be in a regular cash ISA if you choose a cash Lifetime ISA. However, you are not protected from investment losses if you choose stocks and shares LISA. Find out more about how stocks and shares ISAs are safeguarded.
Innovative finance ISAs
Innovative finance ISAs allow you to lend to others while receiving tax-free interest.
If you put money into an innovative finance ISA (IFISA), the company that offers the ISA will use it to lend to borrowers or businesses (this is often known as peer-to-peer lending). Here are the most important things you should know…
- You earn interest on your money if you lend it out. The concept is that you will receive money in the form of a percentage of the interest rate charged to the borrower on their loan. Because the ISA provider takes a cut, it’s rarely the full rate.
- Your interest is not taxed if you lend through an IFISA. You can lend like this without putting it in an ISA, but if you do, any interest you earn from lending money to other people (or businesses) is tax-free.
- If the people you’ve lent money to are unable to reimburse you, you may lose money. Because you’re lending money, there’s a danger the borrower won’t pay it back. Spreading your cash across various loans or using provider-backed safety funds can help limit risks. However, if a large number of your debtors default, your funds are likely to suffer.
If you wish to withdraw your money, it may take some time. You may have to wait for other investors to come along and purchase you out of your loan. This can be quick, especially in a booming economy, but we witnessed a lot of peer-to-peer investors seeking to sell their loans during the coronavirus pandemic and having to wait many months.
An innovative finance ISA does not protect your savings.
Any money you put into an innovative finance ISA provider and has been leased out to borrowers is unprotected. The IFISA provider may have a safeguard fund in place to help limit losses, but it is not required.
Even if they do have a safeguarding fund, it’s unlikely to be large enough to preserve everyone’s money in the event of a large-scale economic downturn that causes a considerable number of people to default on their loans. So, if you’re thinking of investing in an IFISA, make sure you only put money in that you can afford to lose if things go wrong.
Junior ISAs are a great way to put money aside for your child’s future.
A junior ISA
A junior ISA is a variation of the ISA designed specifically for children (JISA). It allows you to save tax-free on behalf of a child, just like the adult version. You can either save or invest for your child, or a combination of the two. In summary…
- A JISA allows you to save up to £9,000 per year (for the years 2021/22). This is less than half of the adult ISA allowed, but it is separate, so you may save £20,000 in your ISA and £9,000 in your child’s junior ISA in the same tax year.
- The annual JISA allotment can be split between cash and stocks and shares JISAs. So you have the option of putting it all in cash or all in stocks and shares (or any mix of the two).
- Children are not allowed to handle money until they reach the age of eighteen. Although the account is in the child’s name, you are the one who opens and manages it. The child can assume responsibility at 16, but they won’t be able to touch the money until they’re 18 (at which point it will be their money, not yours).
So, while you may have put money aside to help them pay for college or a down payment on their first home, they may opt to spend it all on partying, and you won’t be able to stop them.
- A cash JISA can only be held by your child with one provider. It’s the same with a JISA for stocks and shares. This means that you continue to top up with the same provider year after year. You may always switch your child’s JISA to another firm if you’re unhappy with the provider or find a better offer elsewhere – but you’ll have to transfer everything.
Note: If your child reaches 16 or 17, the ISA system has a strange peculiarity in that they get two allowances: the junior ISA allowance AND the adult cash ISA amount of £20,000.
If your child has a Child Trust Fund, here’s what you should do…
CTFs (Child Trust Funds) were the forerunners to junior ISAs, and they were available to children born between September 2002 and January 2011.
A Child Trust Fund can now be transferred to a JISA account by anyone who has one. This will be the proper thing to do in most circ*mstances, but not all. Read our Child Trust Fund guide to see if it’s the correct solution for you.
In a cash JISA, your money is safe, but in a stocks and shares JISA, it’s at risk.
Your savings are protected in the same way as they would be in a regular cash ISA if you choose a cash junior ISA. However, you are not shielded from investment losses if you choose stocks and shares junior ISA. Find out more about how stocks and shares ISAs are safeguarded.
