What are ISAs?
One of the main account types I constantly recommend on this blog is an Individual Savings Account a.k.a. an ISA. Although most people have heard of it, not many truly understand all the different types and the benefits they can bring. Its these benefits which differentiates ISAs from a standard saving or investment account.
Tax Benefits
The biggest benefit you can gain from using an ISA, no matter the type, is the protection it grants from capital gains tax and from dividend tax. In the UK currently everyone has a capital gains tax free allowance of £3,000 per tax year.
If your money outside of an ISA earnt you over £3,000 in gains you would be forced to pay capital gains tax on this amount at a minimum rate of 24% . If that same money was actually inside of an ISA you would keep the whole amount.
The same goes for dividends however this years dividend tax allowance currently sits at £500 meaning you would have to pay a minimum of 8.75% tax on anything over this threshold. Once again if the asset sits within an ISA you don’t have to pay it.
Tax Comparison, Savings Account vs. Cash ISA
Starting Amount |
Interest Rate |
Account Type |
Tax to be Paid |
Net Total after 1 year |
|---|---|---|---|---|
£100,000
|
5%
|
Savings Account
|
£480
|
£104,520
|
£100,000
|
5%
|
Cash ISA
|
£0
|
£105,000
|
As you can see from the table above you need a lot of money to generate over £3,000 from a regular savings account. In fact at 5% interest you’d need £60,000 just to reach £3,000.
For most people the tax benefits of a Cash ISA aren’t applicable as they simply don’t have enough money to break through the tax threshold.
Stocks and shares however can rise exponentially. Upon their sale you could be hit with a very big tax bill, hence my penchant for using a Stocks & Shares ISAs.
ISA Allowance
The other point which makes the prior scenario harder to achieve is that across all ISAs (excluding Junior ISAs) you can only put up to £20,000 per tax year. This is known as your ISA allowance.
You are given a new £20,000 limit every tax however if you didn’t max out this £20,000 within the tax year this does not carry over and you cannot go back and utilise it. Essentially its use it or lose it.
As of 2024, you can utilise your allowance more freely by contributing to multiple Cash ISA and Stocks and Shares ISA accounts within the same tax year. Previously you could only contribute to one of each account type per tax year.
Types of ISA
There are currently 5 different types of ISA in the UK which anyone can open and use.
Lets understand the use of each one.
Cash ISA
The Cash ISA is essentially a tax protected savings account. You can put any savings in up to £20,000 per tax year and it will earn you a percentage interest. They come in two different types, instant access or fixed rate/term.
Instant Access:
With instant access you can remove your money at any point. The interest rate is also variable and so can fluctuate over time.
Fixed Rate/Term:
With a fixed ISA the interest rate is fixed at a set percentage usually for 1 year however this can vary. Your money would then be locked away until the maturity date when your interest would be applied.
Main Uses:
The main use is when you want to save larger amounts of money as cash to avoid paying tax. This could be for a house deposit or just for financial security. They also come in handy for smaller amounts when, like recently, they have a high percentage interest making them competitive with standard savings accounts.
Recommended Reading: Learn how to create the perfect budget for you with Budgeting For Beginners.
Stocks & Shares ISA
The Stocks & Shares ISA (S&S ISA) is the tax protected equivalent of a General Investment Account (GIA).
It allows you invest in variety of assets including funds, shares, stocks and exchange traded funds (ETFs). This means you can invest in companies all over the world safe in the knowledge that when you sell you wont have to pay capital gains tax .
Any dividends you receive whilst you own them will be exempt from dividend tax as well.
Main Uses:
If you want to get started in investing outside of your pension, then a Stocks and Shares ISA is the best place to start.
For me a S&S ISA is huge part of my wealth building goals. They offer the opportunity to build vast amounts of money through the stock market whilst being able to access the money at any point. This makes them brilliant for retirement planning to supplement a pension. It’s such a shame that only 6% of the UK population have made use of them in 2024.
The world of investing can seem especially daunting to someone just getting started so I will be delving into this world with my next post being on the subject of choosing a S&S ISA provider.
Recommended Reading: The best way to set effective Financial Goals.
Lifetime ISA
The Lifetime ISA (LISA) is a more complicated ISA option but has two major use cases being for saving for a house deposit and saving for retirement.
It comes in two forms, a Stocks and Shares LISA and a Cash LISA.
Key Details:
- You can only pay into one LISA in a tax year.
- You can only contribute a maximum of £4,000 in a tax year.
- If you max it out, you would have £16,000 left of your overall ISA allowance to split between the other ISA account types.
- You must be between 18-40 years of age to open one and you cannot contribute anymore after the age of 50.
- The government adds a 25% bonus to any deposits. This equates to £1000 when you contribute £4,000.
- You can only withdraw money for buying your first home or at the age of 60. Other withdrawals will incur a 25% withdrawal charge.
See the Gov.co.uk guidelines here for the most up to date Lifetime ISA rules.
Buying your first home:
The LISA is a great tool for saving up for your deposit as the extra 25% bonus means you can save £5,000 per tax year towards your home. The home must also cost under £450,000.
I personally have a Cash LISA exactly for this purpose. I didn’t want to risk my money decreasing right before buying a property which ruled out using the Stocks and Shares LISA for me.
The recent higher interest rates have also helped increase my pot on top of the 25% bonus helping me to get ever closer to getting on the housing ladder.
Retirement Planning:
After I have bought a house utilising my Cash LISA I can still open a S&S LISA and utilise the 25% bonus. This means instead I could invest in this way to be able to access these funds at 60 thus helping me with retirement.
This is an interesting option however its worth consider pension options due to better tax benefits or the normal S&S ISA as you can then access this money at any point.
Recommended Reading: Check out my early career retirement planning guide.
Innovative Finance ISA
These are higher risk products as they allow you to invest in Peer to Peer (P2P) lending within the tax free ISA wrapper.
P2P is essentially where you become the person providing debt. Small companies, individuals and investors can then use this money giving you a percentage interest when they repay it. This will be shown as a target return.
The word target should not be ignored as there is a possibility of the borrower defaulting and being unable to pay back the loan resulting in you losing your money. The higher the target return usually the greater the risk of this occurring.
It’s also worth noting that this type of investment is not usually covered by the FCS (Financial Compensation Scheme) unlike with many stocks and shares ISA platforms.
Just like with Cash and S&S ISAs you could invest your whole £20,000 yearly ISA allowance in an IFISA. I would not recommend this however due to the risk and you can get just as good if not better returns via the stock market.
If you are interested maybe try with lower amounts one tax year to get a feel for whether this investment is right for you.
Junior ISA
The final ISA is the Junior ISA and is the only ISA which does not impact your £20,000 allowance. As the name suggests this is a product for your child and it allows you to deposit up to £9,000 per tax year into the account in their name.
Once the child turns 18 the account will turn into either a Cash ISA or Stocks and Shares ISA account. They will then have full access to the money and be able to invest or spend it as they wish.
If you don’t like the idea of them splashing all this cash at 18 you could opt for a junior SIPP instead which will give them a major head start on their retirement savings.
The Junior ISA can be opened either as Cash or Stocks and Shares. In my mind the junior S&S ISA is the most compelling option. It will allow you to take advantage of 18 years of compounding whilst teaching your child about investing in a way where they will see the results. Even small monthly investments will go a long way after 18 years of growth!
Recommended Reading: Understand the power of Compounding, it could just change your life.
Conclusion
There you have it a short summary of each of the UK ISA accounts. I will aim to keep this updated with the most up to date information but please see the Gov.co.uk website here for the current rules around ISAs.
I hope you’ve found this explanation informative and hopefully it has given you a greater understanding about how to best use these types of accounts.
Next up, an in-depth look at choosing a Stocks and Shares ISA provider. Happy Investing!
Disclaimer
All information is not financial advice and is purely meant for educational purposes only. Investing involves the risk of loss of capital as well as its gain. Any investments mentioned on this website are meant as examples not specific recommendations. Always do your own research and/or gain the help of a financial advisor.
