Individual savings accounts (ISAs) are tax-free, so they should be your first port of call if you are looking to kick-start the savings habit.
This tax year (2016/17) you can put up to £15,240 into an ISA. Thanks to new rules introduced in July 2014 you can invest the full amount in cash if you wish to.
If you have yet to use this year’s ISA allowance, you’ve got until April 5, 2017 to make the most of it. If you don’t use your allowance by this date, it will be gone for good, as you cannot carry any allowance which you haven’t used over to the following tax year.
Don’t wait until the very end of the tax year to invest either, as you will miss out on valuable tax-free returns. For example, if you had invested the maximum £15,240 cash ISA allowance at the time on April 6, 2016, into an ISA paying 1.50%, by the start of the following tax year on April 6, 2017, you would have earned a respectable £230 in interest.
However, if you wait until the end of the tax year, and invested the same allowance on March 6, 2017, you’ll have earned just £20 in interest by April 6, 2017.
Junior ISAs (JISAs) work in a similar way as adult accounts except they are specifically for children, and enable mums and dads to save on their offspring’s behalf tax-free.
Parents can choose from stocks and shares JISAs, where your money is invested in the stock market, and the less risky cash JISA which is basically a tax-free savings account. This tax year you can pay up to £4,080 into a Junior ISA.
Remember that the account will be held in your child’s name, so only they can get their hands on the money. They will not be able to do this until they reach the age of 18, although they can choose to manage the account themselves once they reach 16.
Different kinds of ISA
Cash ISAs work in the same way as standard savings accounts, except that returns are tax-free.
If you choose a variable rate account, then the interest you earn can change over time. Be aware too that many variable rate ISAs include an introductory bonus in the rate, which usually disappears after the first year. If you find your interest rate suddenly plummets, you should consider transferring your savings into an alternative better-paying ISA.
With a fixed-rate cash ISA, however, the interest rate won’t change during the term of the account, and you can often earn more than you could if you put your money into an easy access ISA.
However, fixed rate ISAs don’t usually allow withdrawals, so you’ll need to be sure you can afford to lock away your money for a year or more, depending on the account term. As a general rule, the longer you are prepared to leave your money untouched, the higher the rate of interest you will earn.
Alternatively, if you have a strong stomach for risk, you might want to think about putting your money into a stocks and shares ISA instead. Bear in mind that stocks fall as well as rise, so you could end up getting back less than you put in. Historically, however, stocks and share tend to outperform cash accounts if you’re investing over a long-term period.
There are numerous different investment funds to choose from, so if you aren’t certain which funds to pick, you should speak to an Independent Financial Advisor (IFA) who will be able to make some suitable recommendations. However, you will have to pay for this advice. It's usually a good idea to pick a variety of investment funds to help spread the risk.
Finding the best deal
If you're still wondering where to invest your ISA allowance, MoneySuperMarket compares hundreds of different deals in a matter of moments.
Remember too that in addition to ISAs, all basic rate taxpayers can now earn £1,000 of savings interest a year without having to pay any tax on it thanks to the new Personal Savings Allowance (PSA). 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.