ISAs Explained
Unsure what an ISA is and how they work? Our guide outlines the different types of ISA and explains the key things you need to know
What is an ISA?
An ISA is a savings or investment account which allows you to save and earn interest tax-free in the UK.
There are two main types of ISA, a cash ISA or a stocks and shares ISA.
A cash ISA is similar to a normal savings account, in that you will be paid interest on the balance.
In contrast, a stocks and shares ISA, or equity ISA, is an investment account where your money will be put into a range of assets. Like any investment, this means its value could go down as well as up.
ISA stands for Individual Savings Account. The main point of difference from other savings and investments is that ISAs are free from tax up to the first £20,000 you save in any given tax year.
How do ISAs work?
ISAs work in the same way as other savings or investment accounts except they offer more tax-free benefits.
You can open an account at a range of leading UK providers, including banks, building societies, insurers and investment firms.
Each year, you can then save up to £20,000 in your chosen account or split the allowance across more than one account. The UK tax year runs from 6 April.
Cash ISAs are the most straightforward option. Your savings accrue interest tax-free and this is added to your balance.
Stocks and shares ISAs can be more complicated. You may have a choice of where you invest the money and how it is managed. There might also be fees to pay. Like any investment, there’s the potential for the value to go down as well as up.
You can also often move your existing ISAs to new accounts without losing the tax-free benefits, but check with your provider first.
What are the different types of ISA accounts?
Cash ISA
What is it?: A tax-free savings account
How does it work: You can save up to £20,000 tax-free each tax year. As with regular savings accounts, there are both fixed-rate and instant or easy-access options available. You are eligible once you turn 16
Main benefit: While a Cash ISA might not pay high amounts of interest, your money is secure and you benefit from its tax-free status
Stocks and Shares ISA
What is it?: A tax-free investment account
How does it work: You can save up to £20,000 tax-free each tax year and your money is invested in the stock market. Depending on the account, you have various options for investing and managing your ISA. Some stocks and shares ISAs have annual fees. You are eligible once you turn 18
Main benefit: A stocks and shares ISA gives you the opportunity to take advantage of equity growth, meaning you could get a better return on your money. But as with all investments, there is a chance the value of what you hold could go down as well as up
Lifetime ISA
What is it?: A type of ISA designed to help you pay for your first home or save towards retirement
How does it work: A Lifetime ISA can be a special type of stocks and shares ISA or regular cash ISA that allows you to save up to £4,000 a year tax-free. The Government then adds a 25% bonus that can be used specifically to buy a house or for retirement. It can only be opened by those aged 18 to 39
Main benefit: The 25% Government bonus allows first-time buyers to build up a bigger deposit for their first home. But it must be used for this purpose or invested until you reach 60. If you withdraw it earlier, you face losing the bonus as a penalty
Junior ISA
What is it?: A savings or investment account. Available to those under 18
How does it work: You are limited to putting away £9,000 a year, but as with other ISAs you benefit from tax-free returns. A Junior ISA can be held in either cash or stocks and shares. Parents and guardians can open accounts on behalf of children, but access to the funds is not permitted until the child turns 18
Main benefit: Allows children to get into the savings habit while them tax-free returns each year
Am I eligible for an ISA?
To open an ISA you will need to be a UK resident. Whether you are eligible will also depend on your age, as there are different rules depending on the type of ISA…
Cash ISA. Aged 16 or over
Stocks and shares ISA. Aged 18 or over
Lifetime ISA. Aged 18 to 39.
Junior ISA. Aged under 18 (parents or guardians can open the account on the child’s behalf)
What is the allowance for an ISA?
The ISA allowance is the maximum you can put into an ISA each tax year in the UK. This currently stands at £20,000 per person over the age of 16.
It’s important not to confuse this with the personal savings allowance or PSA, as this is entirely separate. The PSA is set by the Government and is the amount you can earn in interest per year without paying tax on it. A basic-rate taxpayer can currently earn up to £1,000, while a higher-rate taxpayer can earn up to £500.
The benefit of ISAs is that any interest you earn doesn’t count towards your personal savings allowance because it’s already tax-free.
Equally, if you’ve exceeded your personal savings allowance, opening an ISA can be a good way to continue earning interest tax-free.
How many ISAs am I allowed to open?
In any one tax year you can have just one ‘active’ cash ISA. But you can also invest in a stocks-and-shares ISA, and / or an innovative finance Isa, provided you don’t go over your £20,000 allowance.
You can transfer your cash ISA or other ISA funds to a new provider (if it will accept transfers) and this will not affect your annual ISA limit.
What are the ISA rules?
Saving or investing in an ISA is relatively straightforward.
You can save up to £20,000 into ISA accounts each year tax-free
You can only save into one cash ISA and one stocks and shares ISA each year and the combined amount shouldn’t exceed £20,000
You are likely to be able to move an existing ISA to a new ISA account and keep it within its tax-free wrapper. This doesn’t count towards your annual £20,000 allowance
The amount you save or invest tax-free in an ISA does not count towards your personal savings allowance
How do ISA transfers work?
When looking to switch into a new cash ISA, contact the provider and fill out a transfer form. Don’t just withdraw the cash, as you’ll lose the tax-free status of your savings.
You can usually transfer funds from a previous year’s ISA, though you need to check if your account permits this, as not all do.
Our guide to transferring an ISA gives you more details on the transfer procedure for different types of ISAs.
What are the alternatives to ISAs?
While an ISA could be a great choice for you, it’s also worth looking at the other savings options – particularly as the interest rates could be higher. These include:
Fixed-rate bonds – these are fixed-rate savings accounts into which you can put cash away for a set period. In return for tying up your money,you should earn slightly higher rates. There are likely to be penalty fees if you need to access your money during the fixed rate term.
Easy-access accounts – if you prefer easier, penalty-free access to your savings, an easy-access account may be a better choice. Rates may be lower than on fixed accounts, although some easy access accounts might pay a short-term bonus. Always check when the rate is due to fall or the bonus rate ends, so you can switch to a better paying account if possible.
High Interest current accounts – some standard bank accounts pay a decent rate of interest, but be sure to read the small print to see what you need to do to get those high rates. Some accounts will have a minimum amount you’ll need to deposit each month to get that rate. In other cases, there may be a limit on the balance – so you may only earn the interest on the first £1,000 of cash, for example.
Other useful guides
We have a range of guides with more information about savings accounts and Isas, including:
Compare ISAs with MoneySuperMarket
Before you choose a new ISA account it’s important to shop around and compare the different types of ISA on offer and the potential returns they offer.
MoneySuperMarket can help with your search as we list ISA accounts from a range of leading UK providers.
You can compare rates – see if they’re fixed or variable rates – or if they include a bonus rate. Once you’ve made your choice you can simply click through to the provider to start with the opening of your new ISA.