What is an ISA?

Everything you need to know about ISAs and tax-free savings

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ISAs are more flexible than ever, giving savers more control over their money.

ISAs can sometimes feel complicated – with an array of options available, it can be difficult to know which is right for you. We’ve put together a comprehensive guide to the different types of ISAs you can open and how they can help you get tax-free interest on your money.

What is an ISA?

An ISA, or individual savings account, is similar to a standard savings account in that you can deposit money and earn interest, but with the added bonus of not paying tax on it up to a set limit.

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How do ISAs work?

ISAs work by letting you save money either as a lump sum or with regular monthly payments every tax year. Cash ISAs have a savings limit up to which you won’t pay any tax on the interest you earn, while stocks and shares ISAs let you invest without paying tax on your income or capital gains from these investments.

When the tax year ends you won’t be able to save any more into that ISA – your allowance will be reset and you can then open a new ISA.

You can open a new ISA every year and pay in up to the set limit – once the money is in your ISA it can’t be taxed, no matter how long it’s in there. However the interest rate may not be as competitive after the first year, so you might consider transferring it into a new ISA with a better rate.

You can accrue savings from multiple years so long as each amount from each year was on or under the limit – and transferring this into a new ISA every year means you can maximise the interest you earn. There are no limits on how many times you can transfer an ISA.

Keep in mind that you could lose money if the value of your investment falls, so if you’re adverse to this kind of risk then investment ISAs may not be best for you.

How much can I save in an ISA?

In the tax year 2020/2021, the tax-free ISA allowance is £20,000 - meaning over the course of the year you can put away or invest up to £20,000 without paying tax. This can be spread across multiple ISA products up to that limit.

For example, the savings limit for Cash ISAs has been £20,000 since the 2017-2018 tax year – so if you were to save the maximum every year since that year, by the end of the tax year 2020/21 you could have £80,000 in your ISA. This would be earning interest on which you would pay no tax.

What types of ISA can I take out?

ISAs come in four main variations:

  • Cash ISAs
  • Stocks and shares ISAs
  • Innovate finance ISAs
  • Lifetime ISAs

What is a cash ISA?

Cash ISAs are basically the same as normal savings accounts, except they let you earn tax-free interest up to a set limit every tax year. You’ll be able to choose from three different types of cash ISA, depending on your saving habits and requirements:

  1. Fixed-rate cash ISAs: If you open a fixed-rate ISA you’ll be rewarded with a fixed interest rate, so you know how much your money will be earning. However you’ll only keep this rate if you leave any money in there untouched – withdrawing funds means your interest rate will likely drop
  2. Regular savers cash ISAs: Regular savers also usually offer a fixed interest rate, but you’ll need to make a regular monthly payment into the account to keep it
  3. Instant-access cash ISAs: Instant-access ISAs are the most flexible, so you’ll be able to add and withdraw as you please – but in return your interest rate probably won’t be fixed, so it may go down as well as up depending on the market rate

What is a stocks and shares ISA?

Stocks and shares ISAs offer an alternative way to earn without paying tax – you can use your £20,000 allowance to invest in stocks and shares, and get your capital gains and income tax-free.

You can choose to have your account managed, in which case exactly where your investment goes is taken care of for you, or you can manage it yourself through a self-select ISA and choose where you invest. It’s likely you’ll need to pay a fee either way.

As with all investments, however, there is an element of risk that you may not get all your money back. You should be aware of this before opening a stocks and shares ISA.

What is an innovative finance ISA?

Innovative finance ISAs also carry an element of risk – the money you invest is lent to borrowers taking out peer-to-peer loans, often people who either didn’t want to, or didn’t qualify for, a standard personal loan.

They’ll repay the money you invest with a rate of interest, and usually the higher the rate you get the riskier the investment.

What is a lifetime ISA?

Lifetime ISAs are part of a savings scheme backed by the UK government as a way to help people save up for retirement or their first home. These ISAs can be cash savings or stocks and shares investments.

The savings limit works differently for lifetime ISAs – you can save or invest up to £4,000 every tax year, but this will come out of your overall £20,000 allowance for the year.

You won’t be able to access any money until you’re 60 if it’s for retirement, and you’ll only be able to pay into it until you’re 50. If you’re saving for a property it must be your first.

Who is eligible for an ISA?

Anyone over 18 can open a cash, stocks and shares, or innovative finance ISA, but for a lifetime ISA you must be aged between 18 and 39.

You can also open an ISA for someone under 18, but it will be under your control until they turn 18 – these are called Junior ISAs.

What is a junior ISA?

Junior ISAs are what you can open for your child if you’re a parent or guardian and they’re under 18. You can pay in up to £9,000 each tax year – this won’t come out of your own allowance – and when your child turns 18 it will convert into a full adult ISA.

Are ISAs worth it?

Putting money aside is always a good idea if you can afford to do so, but you might be wondering whether it’s worth opening an ISA compared to a standard savings account. Here’s what you should consider before deciding:

  • Interest rates: ISAs might not offer interest rates as high as standard savers, but they offer savings on tax payments – you can work out which will offer the best return using our savings calculator before you open an account
  • Savings limit: You only avoid paying tax on £20,000 this tax year (2020/21) with an ISA. If you think you’ll be saving more, you can open a savings account to capitalise on the potentially higher interest rates
  • Tax-free allowance: Also consider that depending on income and tax rate, you’ll also have a personal savings allowance that lets you earn tax-free interest on regular savings – but this limit is lower than with an ISA
  • Options: The ISA market is significantly smaller than standard savings accounts, so you might find your options to be more limited

Finding the best deal

If you're looking to open a new ISA for this tax year, MoneySuperMarket can help you find an account in just a few moments. All you need to do is decide which type of ISA you need – remember to factor in how soon you’ll need access to the money and who it’s for.

You’ll be able to compare accounts by the interest rate you’ll get and the minimum amount required to open the ISA – once you find the one you want, just click through to the provider to get started.

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