What is an ISA?
As interest rates have fluctuated over the years, so has the ISA’s (Individual Savings Account) competitiveness against other types of savings accounts. Despite this, ISAs are now an important part of many people’s savings strategies. But what is an ISA, and how do they work? In this guide, we explore the meaning of ISA, the different types of ISA you can open, how they all work and what you might want to consider when opening an ISA. We also take a look at some of the alternatives to ISAs, including fixed rate bonds and notice accounts.
ISA types: There are several types of ISAs including cash ISAs, stocks and shares ISAs, the lifetime ISA and the innovative finance ISA
ISA rules: You can have multiple ISAs, but you can only pay into one ISA per tax year
Tax-free interest: You can save up to £20,000 in an ISA per tax year, and any interest you earn will be tax-free
What is an ISA, and how do they work?
An ISA – which stands for ‘Individual Savings Account’ – is a tax-free savings or investment account. You can save up to a maximum of £20,000 per tax year (traditionally 6th April to 5th April), and you can choose from a few different types of ISA:
You can open more than one type of ISA, but the most that you can save per tax year applies to you as an individual, not to each account you open. Depending on your savings goals, you could put all your savings into one type of ISA, or you could split your savings across different types of ISA. The £20,000 limit is a combined limit across all the ISAs you hold, and you can only save into one of each type of ISA per year.
ISAs are available through a variety of providers including banks, building societies, stockbrokers, credit unions and other financial institutions.
What are the different types of ISA?
There are several different types of ISA, all of which provide the benefit of tax-free savings:
1. Cash ISA
A cash ISA is similar to a traditional savings account. The difference is that there’s a limit of £20,000 on your deposits each tax year. But what is a cash ISA exactly, and what does it offer? There are three types of cash ISA, and they all offer tax-free savings interest: instant access cash ISA, regular savings cash ISA, and fixed rate cash ISA.
With an instant access cash ISA, you can deposit and withdraw money any time you wish without penalty, although your ISA provider may impose a limit on how often or the number of times you can do this. Instant access cash ISAs are a good option to consider if you want the flexibility to withdraw money from your savings but don’t know when you’ll need to do so.
With a regular savings ISA, you typically earn a fixed interest rate as long as you deposit an agreed amount of money each month. You can save up to £1,666 per month without going over the £20,000 annual limit.
Similar to fixed rate bonds, fixed rate cash ISAs commit you to locking away your money for a set amount of time to earn a competitive interest rate. As you consider your options, keep in mind that, in general, the longer the term on a fixed rate cash ISA, the higher the interest rate you can earn.
Some cash ISAs are flexible, meaning you can deposit and withdraw money from your account without it impacting your yearly tax-free allowance. The main stipulation is that you replace any money you take out within the same tax year. This is different to a non-flexible ISA, where any funds you withdraw will still count towards your ISA limit for that year.
2. Stocks and Shares ISA
A stocks and shares ISA is an investment savings account that can include shares in companies, government and corporate bonds and investment funds. You can choose to open a managed account and pay for someone to manage your investments on your behalf, or you can make your own decisions on where to invest your money. Your investments are protected from UK tax, meaning you don’t have to pay income or capital gains tax on the money you earn.
3. Innovative Finance ISA
Also known as an IFISA, an innovative finance ISA is a savings account that lets you use your ISA allowance while investing in peer-to-peer loans, or investments you make in a business by buying its debt. This type of account matches investors with borrowers who do not want or cannot get a traditional bank loan.
4. Lifetime ISA
A lifetime ISA, or LISA, is only available to people over 18 and under 40, and it’s intended to help them buy their first home or save for retirement. Unlike other types of ISA, you can only save up to £4,000 per tax year in a lifetime ISA. The government will then add 25% to your savings up to £1,000 per year. You can only withdraw money from a lifetime ISA if you are buying your first home, if you are over 60, or if you are diagnosed with a terminal illness.
5. Junior ISA
A junior ISA, or JISA, is a savings account that you can set up for a child below the age of 18. They’re often created to help secure a more stable financial future for the next generation. While the junior ISA will be in your child’s name, you or a legal guardian will need to open and manage the account until they turn 18. There are two types of junior ISA – a cash junior ISA or a stocks and shares junior ISA - and you can contribute up to £9,000 per year to this savings account
6. Help to Buy ISA
There’s also another type of ISA specifically designed to help first-time buyers save for a mortgage deposit. The Help to Buy ISA gives you the chance to earn a 25% government bonus, worth up to £3,000. These accounts are now closed to new applicants, but if you’re an existing account holder you can continue to save into your Help to Buy ISA until 30th November 2029.
Is an ISA tax-free?
Yes, you will never have to pay tax on interest earned in ISA savings accounts. This includes interest on your money in a cash ISA and income or capital gains from investments in a stocks and shares ISA. ISAs are a good option to consider if you have a lot of savings or are an additional rate taxpayer. You may also want to explore whether it’s better to have monthly or annual interest on an ISA. If you intend to save into an ISA over a long period of time, the effect of compound interest can be very financially rewarding.
What is the ISA allowance?
Every tax year, you get an ISA allowance of £20,000, which is set by the government and represents the maximum you can put in an ISA(s) without paying tax on your returns. The tax year typically runs from 6th April to 5th April. You can use the entire allowance in one ISA or spread it across different types of ISAs as long as you stick within the £20,000 limit. If you don’t reach the ISA limit, it won’t roll over to the next tax year.
What to consider when opening an ISA
When opening an ISA, the first thing you might consider is what you are saving your money for, as this will determine the type of ISA that’s best for you. For example, if you’re setting aside cash for an emergency fund, you’ll need to be able to access it at short notice, so an instant access cash ISA might be right for you. On the other hand, if you want to save over the long-term and take advantage of compound interest, a fixed rate cash ISA might be more suitable.
It’s also worth comparing the ISA savings rates with those offered on other types of savings accounts. Some cash ISAs feature variable interest rates that typically give lower returns than other savings accounts, while others offer attractive introductory rates that drop after a year. It’s worth comparing your options, as you may be able to earn more interest with other types of savings accounts. You might consider fixed rate bonds as an alternative; they often come with competitive rates and provide the certainty of knowing exactly how much interest your savings will earn.
Advantages and disadvantages of ISAs
Whether you open an ISA or other type of savings account will depend on the particular ISA features, your financial situation, preferences and savings goals, but you might consider these factors:
Advantages:
Returns on ISAs are tax-free
Various ISA types cater to different investment preferences
You can transfer ISAs between providers or account types at any time
Disadvantages:
The annual ISA limit could be unsuitable for larger investments
Stocks and shares ISAs are subject to market fluctuations
The returns on a cash ISA can vary due to variable interest rates
Can you have more than one ISA?
Yes, you can have more than one ISA. While you are only allowed to deposit money into one type of ISA per year, you can still hold any ISAs you’ve opened previously. Remember, you can only save up to £20,000 per year, no matter how many ISAs you have.
The alternatives to ISAs
While ISAs are tax-free, it’s worth remembering that the personal savings allowance (PSA) means most people won’t pay tax on their savings anyway. Currently, the PSA lets a basic rate taxpayer earn up to £1,000 in interest without paying tax on it, while a higher-rate taxpayer can earn up to £500. Unless you expect your savings income to exceed the PSA, it might be worth considering non-ISA savings accounts.
Fixed rate bonds can be a good alternative to ISAs, especially if you’re a long-term saver. They typically offer competitive interest rates in return for locking away your money for a set period, usually between six months and five years. Generally speaking, the longer the term, the higher the interest you’ll receive at the end. You can read more about the differences between fixed rate bonds and ISAs on our website.
If you’d like a little more flexibility, a notice account may be a suitable option. These accounts still offer a competitive interest rate, but they allow you to withdraw your savings after a set notice period. The notice period can vary depending on the account, but it’s typically between 30 and 90 days.
In some cases, you might choose to combine the tax benefits of an ISA with the potentially more competitive interest rates of a savings account. Opening an ISA alongside a savings account might be beneficial if you’ve exceeded your personal savings allowance, letting you continue earning tax-free interest. For more information on the differences between ISAs and savings accounts, see our ISAs vs savings accounts comparison.
Opening a savings account at Raisin UK
Although we don’t currently offer ISAs at Raisin UK, you can open other types of savings accounts from our partner banks through our marketplace. You first need to open a Raisin UK Account; then you can apply by logging in, applying for a savings account and transferring your deposit.
If you’ve got any questions, please contact our UK-based Customer Service team, who will be happy to help.