The tax breaks offered by ISAs make them the best way for most people to save. You'll need to know how they work first though, so find out with this short guide.
What is a cash ISA?
A cash ISA works in much the same way as an ordinary savings account, except you do not pay tax on the interest you earn.
ISAs are in addition to the new Personal Savings Allowance (PSA), which came into effect on April 6, 2016. All basic rate taxpayers can now earn £1,000 of savings interest a year without having to pay any tax on it. You’re a basic rate taxpayer in the 2016-17 tax year if your income is less than £43,000).
If you’re a higher rate taxpayer, paying tax at the 40% rate on an income between £43,001 and £150,000, you’re entitled to a lower PSA of £500 a year.
If you’re an additional taxpayer earning £150,001 or more, you won’t get an allowance at all.
Can anyone open a cash ISA?
You must be a UK resident, aged 16 or over. Junior ISAs are available for younger children. But watch out if you are 16 or 17 years old and the money in your ISA is a gift from a parent as they could be liable for tax on the interest earned.
"You can have multiple ISAs but you can only open one cash ISA in each tax year..."
Is it a good idea to open a cash ISA?
Cash ISAs can be an attractive option for anyone who normally pays tax on their savings.
Although the PSA might, on the face of it, make ISAs appear less attractive, they should not be over-looked, as cash saved within the ISA will be tax-free indefinitely. Even if you don’t have enough savings to earn £1,000 in interest now, it is possible that you could in future.
You might also consider an equity ISA that invests in stocks and shares, though they are more risky and you'll need to invest for the longer term to get the best out of them.
Where do I get a cash ISA?
Like savings accounts, cash ISAs are available from most banks and building societies, as well as supermarket banks and other providers such as the Post Office. You can also open an ISA through a number of online banks. You can compare what’s available using our cash ISA comparison.
Do I have to pay to open a cash ISA?
No, there are no set-up fees for cash ISAs.
How much money can I put into an ISA?
The annual limit for cash, stocks and shares and innovative finances ISAs combined is £15,240 for the 2016/17 tax year.
For the 2017/18 tax year the allowance will be £20,000.
You can invest the full allowance in cash if you want to, or in stocks and shares, or in innovative finance ISAs, or a combination of these.
Do cash ISAs pay high rates of interest?
The rates on cash ISAs vary so you should search the market to make sure you get the best deal.
Are there different types of cash ISA?
Yes. The most straightforward cash ISAs are easy access and pay variable rates of interest. In other words, you can get at your money when you want but the interest rate could go up or down.
Some ISAs pay a fixed rate for a set term, rather like a savings bond. For example, an ISA might pay 2% fixed for three years.
Fixed-rate ISAs often pay higher interest than variable accounts, but you have to be prepared to lock you money away, as there is usually a penalty for early withdrawal.
Can I have more than one ISA?
You can have multiple ISAs, but you can open only one cash ISA in each tax year.
So, if you have opened a cash ISA since April 6, 2016, you cannot open another one until April 6, 2017.
Note, however, that transfers from previous years’ ISA funds don’t count. So even if you have opened a cash ISA this tax year and paid new funds into it, you can still transfer funds from previous cash ISAs into another ISA account – so long as you don’t top it up.
Can I switch my ISA, and my ISAs from previous tax years?
Yes – and you should consider switching if you find an account that pays a higher rate of interest.
However, you should first check whether the new provider accepts transfers and whether your current provider would charge a penalty for moving your money.
How much can I switch?
You can transfer savings from both the current and previous years.
Money from previous years can be split between new cash ISAs, and you can choose to transfer only a portion of the holding in an existing ISA.
However, if you decide to transfer money from the current year’s ISA, you must switch the full amount.
Let’s say you put £5,000 in an ISA in the current tax year and £3,000 in the previous year. If you want to switch to a different ISA in the current year, you would have to transfer the full £5,000 from this year’s ISA. But you could choose to switch only £1,000 from the previous year.
Either way, do not close an ISA if you decide to switch as this will mean losing the tax benefit. Instead, contact your new provider and ask it to arrange the transfer.
Can I switch to a stocks and shares ISA?
Yes, but the rules on transfer amounts are the same. Since July 2014, you can also switch from a stocks and shares ISA to a cash ISA if you want.
Can I withdraw money from an ISA?
You can withdraw money from an easy access ISA whenever you wish, at no cost. Withdrawals from fixed-term ISAs are not usually permitted and penalties apply, which is usually charged as a loss of interest.
Under new flexible ISA rules introduced on April 6, 2016, if you take money out of your ISA, you can pay it back in without this affecting your annual ISA allowance.
In other words, if you put £15,240 into your ISA this tax year and then withdraw £1,000, you can pay this £1,000 back in if you want to and you won’t exceed your allowance.
Are cash ISAs safe?
So long as you open a cash ISA with a bank or building society that is authorised by the Financial Conduct Authority (FCA), you will be protected by the government-back Financial Services Compensation Scheme (FSCS).
The scheme guarantees up to £75,000 per person, so if the bank collapsed, you would be sure to get back that amount.
Bear in mind, however, that the limit applies to each authorised firm, not to each brand.
As Halifax and Bank of Scotland, for example, are part of the same group, you should therefore ensure your combined balances don’t exceed £75,000.