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Individual Savings Accounts (ISAs) are a tax-efficient savings option. Although there are complexities, still it provides a great way to save money without worrying about taxation. This article explains about ISAs, their types, and how they work.
What Are ISAs?
An ISA offers a tax-free alternative to savings. The Personal Savings Allowance permits you to earn up to £1,000 in interest tax-free, but ISAs allow you to save up to £20,000 a year without paying any tax on interest, profits, or dividends earned.
Types of ISA
There are five types of ISA available for you to choose from. Some have guaranteed returns, whereas others rely on external factors like market performance and interest earned on business loans.
The five types of ISA are:
You can open multiple ISAs at a time in a tax year, but they should be different types of ISA. Therefore, if you have multiple ISAs open at a time, you can only pay into one ISA of each type in a tax year.
Cash ISA
Cash ISAs allowance for the 2022/23 tax year is £20,000 with tax-free interest, income, and growth. They have numerous types, so interest rates for some will change, whereas, for others, they will be fixed for a defined period of time.
What Are the Different Kinds of Cash ISA?
There are multiple types of cash ISA such as - easy access, fixed rate, and more. Each ISA serves a different purpose, thus it’s a good idea to check all the available options before making a decision on where to put your savings.
You can only pay into one cash ISA in a tax year, thus it’s important to research and find the right cash ISA.
Cash ISAs can come with easy or limited access, so think about how much money you can afford to keep locked away before opting for a limited-access ISA. It’s also worth considering the annual deposit limit.
Fixed-Rate Cash ISA
Variable Rate Cash ISA
Easy Access ISA
Instant Access ISA
Stocks and Shares ISA
Stocks and shares ISAs allow you to invest money in the stock market without being charged tax on the returns. Like all ISAs, stocks and shares ISAs are subject to the £20,000 annual deposit limit, and you can only open and pay into one stocks and shares ISA in each tax year.
Check out our article for a full breakdown of the best stocks and shares ISAs on the market.
Lifetime ISA
The Lifetime ISA (LISA) is designed for one of two things; buying your first home, or retirement. To open a LISA, you need to be 18 or over but under 40. You can use it to buy a home worth up to £450,000 anywhere in the country or for retirement.
You can save up to £4,000 a year into your LISA, and the government adds a 25% bonus on what you’ve paid in. The bonus is paid monthly, and the maximum bonus you can earn is £1,000 per year.
The withdrawal terms are based on your age and the reason for your withdrawal. You can either withdraw this money to buy your first home at any point after the account is a year old or for any reason on or after your 60th birthday.
If you withdraw money from your account before turning 60 for any reason other than buying your first home, you have to pay a 25% government charge to recover the received bonus. As this will be taken from the total amount in your account, including interest, you’ll ultimately repay the government more than what you initially received.
You can’t pay into your LISA or earn the 25% bonus after your 50th birthday.
The qualifying criteria for the LISA are quite specific. If you’re aged between 18 and 40 and looking to save for either your first house or your retirement, a LISA could be what you’re looking for.
However, the maximum annual savings limit of £4,000 is lower than some other accounts, and the tight withdrawal criteria mean you may need to keep your money locked away for a long time.
LISAs can be cash or stocks and shares, so make sure about the type of account before opening it.
Innovative Finance ISAs (IFISAs)
An Innovative Finance ISA (IFISA) is an ISA that creates interest from peer-to-peer loans and crowdfunding debentures rather than cash deposits or stocks and shares. When you open an IFISA, you can choose which people or businesses you wish to invest in. These beneficiaries will then pay interest on the loans they take out with you.
As you essentially cut out the banking process with this method, IFISAs tend to offer higher interest rates than other ISAs. However, they come with a much higher risk, as borrowers may default on the loan if they go bankrupt, and the deposits you make are not protected by the Financial Services Compensation Scheme (FSCS).
The conditions for withdrawing funds usually depend on your provider. Some IFISAs may need to give prior notice before making a withdrawal, while others might set a specific duration for the account and may impose a penalty for early withdrawal before the agreed-upon date.
Other providers may allow withdrawals at any time, but they usually take up to 8 business days to complete due to the complexity of their lending structure.
We don’t recommend Innovative Finance ISAs due to the exceedingly high level of risk associated with them. Before opening an IFISA, consulting with an independent financial advisor is a must.
Junior ISA
Junior ISAs are for children under the age of 18. All the deposited money into the account is locked away until the child’s 18th birthday, and then the account is automatically converted into an adult ISA.
The parent or legal guardian can open the account on the child’s behalf, but the account will be held in the child’s name. The account is managed by an adult, and once the child reaches 16, they can take over the account. However, they are unable to make withdrawals until they reach the age of 18.
The annual deposit limit can change each year. Currently, the savings limit for junior ISAs is £9,000 for 2023/24. If this limit is exceeded, the excess is held in a separate savings account in trust for the child; it can’t be returned to the donor. Any donors can deposit cash savings for the child, as long as the total doesn’t exceed the annual limit.
Like other ISAs, neither the child, named guardian nor donors have to pay tax on the earned interest.
Junior ISAs are designed to save for your child’s needs like university fees, a car, or job training. They also prove beneficial to help children in learning the benefits of saving for the future.
Cash ISA or Stocks and Shares ISA - Which Is Best for Me?
Cash ISAs and stocks and shares ISAs are the main two accounts people think of when ISAs are being discussed. Both have their benefits and flaws, and the best ISA for you will depend on what you’re looking for.
Similarities and Differences Between Cash ISAs and Stocks and Shares ISAs
Check out the main similarities and differences in the table below.
Cash | Stocks and shares |
|---|---|
Returns are guaranteed | Returns are based on market fluctuations and are not guaranteed |
Interest rates are traditionally lower than market returns | Returns traditionally outpace inflation |
Fixed-term accounts give a guaranteed total return for the end of the term, so you can calculate exactly how much you’ll receive | You may lose money on your investment as market prices may decrease |
You will not be able to choose who your money assists other than deciding on a financial provider to open an account with | Some stocks and shares ISAs will let you choose where you invest and which companies you support |
Better for short-term savings goals | Better for long-term investments of more than five years |
A variety of withdrawal options are available, from instant access to easy access and fixed-term | Withdrawals can usually be made at any time, but usually take approximately three working days to be disinvested and returned to you |
Why Should I Open a Cash ISA?
A cash ISA is best suited for short-term savings where you may need the money at short notice. This could be for a large purchase you’re expecting in the near future, like a car or a holiday, or a short-term deposit location to keep your savings ticking over for any emergency spending that may be required.
Why Should I Open a Stocks and Shares ISA?
Stocks and shares ISAs have traditionally outperformed interest rates over time, but are associated with an element of risk. As your funds will be invested in the stock market, unit prices will rise and fall, which means the value of your ISA will also fluctuate.
What’s the Point of an ISA?
ISAs provide a tax-free alternative to standard saving and investing. No tax is levied on interest earned from cash in an ISA or income from an investment ISA. Therefore, you don’t need to declare any ISA interest, income, or capital gains on a tax return.
How Much Can I Put in an ISA?
You can open and deposit money into one of each kind of ISA in every tax year. The maximum you can save in all your ISAs for each tax year is £20,000. You can therefore deposit that all into one ISA, or spread it across some, or all of the other types of ISA you’re depositing in this year.
You can only pay up to £4,000 a year into a Lifetime ISA.
Gerald has a cash ISA and a lifetime ISA.
On 6 April, he opened a new cash ISA with £8,000, and a stocks and shares investment ISA with £2,000.
He pays £4,000 into his lifetime ISA, so cannot add any extra money into this for the year.
His remaining ISA allowance for the year is £6,000.
Now he has opened a new cash ISA, he cannot deposit any money into his original cash ISA this year, but he can keep this ISA open and will still receive the interest on it. He will be able to decide which of his cash ISAs he would like to pay into on 6 April next year.
He sets up a direct debit payment of £500 a month to go into his stocks and shares ISA.
This makes his total annual ISA allowance of £20,000 a year.
What Your ISA May Include
Cash ISAs can include:
Savings in banks and building society accounts
Some National Savings and Investments products
Stocks and shares ISAs can include:
Lifetime ISAs can be either:
Cash, or
Stocks and shares
Innovative Finance ISAs include:
Peer-to-peer loans
Crowdfunding debentures
Peer-to-peer loans are given to other people or businesses without using a bank. These loans offer higher interest rates than traditional ISAs, but carry a much higher risk as you’re investing in individual people or businesses that may default on their loans.
Crowdfunding debentures are the term used to describe the process of investing in a business by buying its debt. Crowdfunding debentures come with a very high risk as they involve investing in immature businesses, already in debt and may fail.
Neither peer-to-peer loans nor crowdfunding debentures are protected by the FSCS, so IFISAs possess a higher-risk investment than most stocks and shares ISAs. However, the freedom you have to invest in people and businesses you personally believe in can feel very rewarding in itself.
How to Open an ISA
Lots of financial institutions offer different kinds of ISAs, including:
Most ISAs can be applied for online or over the phone. Check the details below to find out how to open an ISA with your chosen provider.
How to Open an ISA With a Bank
Every bank will have a slightly different sign-up process. Some may need you to have a current account with them in order to open an ISA, while others may ask you to open an account in-branch or over the phone. Many of them will also allow you to open an ISA online or via their banking app.
To set up an ISA with the bank, you must provide the requested contact details if you are not yet registered with the bank, and may be required to complete a credit check.
How to Open an ISA With a Building Society
Like banks, individual building societies will have slightly different sign-up processes and requirements, with some needing you to set up an account in person and others being available to open online. Some may even offer sign-up incentives, but beware: these may only last for the first year of your ISA.
To open an ISA with a building society, your chosen provider will provide complete information on their website or in-branch. You may be required to provide the relevant contact information and complete a credit check, if you are new to the building society accounts.
It’s important to conduct your own research on the building societies available to find the one that gives you the best value for your money.
How to Open an ISA With a Stock Broker
Some stock brokers offer stocks and shares ISAs, lifetime ISAs, or both. Some stock brokers will need you to open a standard trading account in order to open an ISA, while others will allow you to open only your ISA of choice.
One of the highlights of stock broker ISAs is that they allow you to choose where your investments are made, with slightly lower risks than peer-to-peer lending services and crowdfunding companies.
Most stock brokers offer ISAs via their apps, so this may be a good option for you if you’re looking for investments you can control personally from home via a computer or mobile device.
To open an ISA with a stock broker, choose your provider and download their app from Google Play or the App Store. You will need to provide them with your contact details as requested.
How to Open an ISA With a Credit Union
A credit union is a financial cooperative that provides savings accounts, loans, and a variety of other financial services to its members. The thing that sets them apart from traditional banks is that the union is owned and controlled by the people who use their services.
To join a credit union, you must have a common bond with other union members. For example, you may live in the same area, work for the same company, or belong to the same trade union. If your credit union provides ISAs, you should then be able to apply for one via their app, website, or customer service team.
For this reason, the eligibility criteria for credit unions are stricter than for most banks and building societies. However, if you find a union you’re eligible to join, you may get to know that they offer a better deal on your ISA or other accounts than traditional banks.
How to Open an ISA With a Friendly Society
Like building societies and credit unions, a friendly society is a mutual organisation owned by its members. A key difference is that all friendly societies must be registered under the Friendly Societies Act 1992, which allows them to offer unique products like tax-exempt savings bonds.
Most friendly societies offer the option to open an ISA online, but each will have its own terms and rates. It’s a good idea to check the individual conditions of the friendly society ISA you’re looking at before opening it. You’ll need to provide some personal details to set up an account.
How to Open an ISA With a Peer-To-Peer Lending Service
Peer-to-peer lending platforms allow you to lend money directly to people or businesses you’d like to support and earn tax-free interest on the interest payments you receive in return. These are high-risk investments as the businesses you’re supporting will usually be small start-ups that may default on their loan.
Like stock broker ISAs, peer-to-peer lending platforms will usually allow you to lend via an ISA through their app and will request relevant contact information from you to set up an account.
How to Open an ISA With a Crowdfunding Company
IFISAs are also available via crowdfunding companies, which allow you to lend to businesses supported by multiple investors and earn tax-free interest on the loan. Like peer-to-peer lending services, they are associated with a very high level of risk as the businesses you’re lending to will usually be start-ups, which may default on their loan.
Crowdfunding companies offering IFISAs will require some personal details to set up an account. You should be able to register online or via the crowdfunding company app.
Who Can Open an ISA?
To open an ISA, you must be:
16 or over to open a cash ISA
18 or over to open stocks and shares or innovative finance ISA
18 and over but under 40 to open a lifetime ISA
Resident in the UK, or a Crown servant/spouse or civil partner of a Crown servant
You can also open a Junior ISA for your child if they’re under 18, providing you are the parents or guardian with parental responsibility.
A Crown servant is an individual employed by the British Crown or works within the civil service of the UK government. You may open an ISA if you’re living overseas but employed by the British Crown or a civil service member, like a diplomatic civil servant working in another country.
Can You Open an ISA for Somebody Else?
Other than the Junior ISA, ISAs can usually only be opened by the account holder. The exception is in cases where the intended account holder does not have the mental capacity to open an account for themselves.
In cases like this, you must have a written power of attorney document stating you are responsible for making financial decisions on behalf of the person, which must have been signed and registered by both of you.
Putting Money Into an ISA
The process for depositing money into an ISA will differ slightly depending on what kind of ISA it is. Some ISAs, like the fixed-term ISA, can only accept one deposit during the whole term of the account. Others, like the innovative finance ISA, need to be accompanied by clear instructions about where you want the money to be invested.
You can deposit up to £20,000 into your ISAs as long as the total amount does not exceed the ISA allowance. This can be in one ISA or all in one, except for the lifetime and junior ISAs. The lifetime ISA carries its own annual deposit allowance of £4,000, and the Junior ISA has a deposit allowance of £9,000.
The annual ISA allowance applies to the owner of the ISA, not the person paying the deposit. Therefore, you could pay up to £20,000 into somebody else’s ISA without impacting your own annual deposit limit. However, the recipient would then not be able to deposit any more money into any of their own ISAs.
As the Junior ISA is held in the name of the child, deposits in a Junior ISA also do not count towards your annual £20,000 deposit limit for the year. However, the total amount that can be deposited in a Junior ISA, wherever the payments come from, is still £9,000.
Transferring Your ISA to Another Provider
You can transfer your ISA to another provider at any time, and you can often transfer your savings to a different type of ISA, but some providers may set their own limits on certain types of transfer. It’s important to check for any restrictions on transfers from both your current and new providers.
A bank may allow you to transfer:
A cash ISA into their cash ISA
A stocks and shares ISA into their stocks and shares ISA
A cash ISA into their stocks and shares ISA
A stocks and shares ISA into their cash ISA
If you want to transfer the money you’ve invested in an ISA during the current tax year, you must transfer all of it to a new provider. To transfer money you’ve invested in previous years, you can choose to transfer all or part of your savings.
If you transfer cash or assets from a lifetime ISA to a different ISA before the age of 60, you’ll have to pay a withdrawal fee of 25%.
How to Transfer Your ISA
To switch ISA providers, you should contact the provider you want to transfer to. They will then provide you with an ISA transfer form, which you need to complete and return to them. Your current provider can’t instigate a transfer for you.
If you personally withdraw money from your ISA, you won’t be able to reinvest that part of your tax-free ISA allowance again. It’s important to follow due process for transfers to avoid losing any tax benefits.
How Long Does It Take To Transfer an ISA?
Transfers can take different amounts of time depending on the type of ISA you’re transferring.
Type of transfer | Transfer time |
|---|---|
Cash ISA to cash ISA | 15 working days |
Cash ISA to another type of ISA | 30 calendar days |
Stocks and shares ISA to another ISA (transferred as cash) | 30 calendar days |
Stocks and shares ISA to another stocks and shares ISA (in-specie) | Up to 12 weeks |
Innovative finance ISA | Check with your provider |
An in-specie transfer is the process of transferring the individual shares, funds, or investment stakes you hold with a provider to another provider, without disinvesting the funds as cash. This can be beneficial if you have a strong interest in your current ISA investments.
Some providers offer in-specie transfers, but they are less widely accepted than cash transfers.
If your ISA transfer is taking longer than it should, contact your ISA provider to check nothing further is needed from your end to complete the process.
Transfer Restrictions
You can transfer cash from your innovative finance ISA to another provider, but you may not be able to transfer other investments from it.
What Happens to Your ISA if You Move Abroad?
If you open an ISA in the UK and then move abroad, you cannot put money into it after the tax year that you move unless you’re a Crown employee working overseas, or their spouse or civil partner.
You must tell your ISA provider as soon as you stop being a UK resident.
You can keep your ISA open while you’re living overseas and still receive UK tax relief on the money or investments held in it. You can also still transfer an ISA to another provider if you’re no longer a resident in the UK.
You can pay into your ISA again if you return to the UK and become a UK resident.
Your ISA may be taxable in your country of residence. Hence, it’s important to check the tax laws in your destination country to ensure you understand what you’re liable for.
Should I open an ISA or a different savings account?
ISAs offer a great way to increase your savings without paying tax on your interest or investment returns. If you’re over your personal annual allowance of £1,000 per year (or £500 for higher-rate taxpayers), an ISA is a great way to boost your savings.
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