1999. Is it a year you remember?
I was wearing fluorescent outfits to school discos and crimping my hair. So, memorable? Yes but fashionable, no.
But 1999 was a big year for another reason.
And that’s the birth of the ISA (or individual savings account).
ISAs were introduced by the UK government to help savers and investors shelter their money from tax and in turn, encourage us to save more.
Back then you could protect £7,000 from tax but the current ISA allowance is much more generous at £20,000 for the 2021/22 tax year.
And it’s not just the ISA allowance that’s changed, there are a few different types of ISAs available now, each with slightly different features and benefits.
Before we start it’s important to know this article isn’t personal investment advice and that tax rules for ISA accounts can change and their benefits depend on your individual circumstances. It’s also important to understand that the value of your investments can rise and fall, and you may get back less than you invested.
How do ISAs work?
ISAs are tax-efficient accounts. This means that whatever is inside your ISA be it cash, investments or a bit of both are protected from a few big UK taxes.
Inside an ISA you won’t have to pay:
- Income tax on dividends or savings interest
- Capital gains tax if you sell your investments for a profit
ISAs go by a few names and the one you’ll likely see a lot of is ‘tax wrapper’. Just like with a sweet wrapper, whatever’s on the inside of the wrapper is protected.
How much can you put in an ISA? Cue the ISA allowance.
Each tax year HMRC sets an ISA allowance and it’s the total amount of money you can put into your ISAs that year.
As we mentioned above the ISA allowance for the 2022/23 tax year is £20,000. And this can be split across different types of ISAs if you’d like.
Compare different ISA accounts
Here’s a short and sweet comparison of the different types of ISAs in the UK.
Stocks and shares ISA
Stocks and shares ISAs (sometimes called ‘investment ISAs’ or ‘share dealing ISAs’) are accounts that protect your investments and any investment growth from owing taxes.
They are an ISA account for those looking to invest their savings and hopefully grow them over the long term.
What do we mean by long-term?
When you invest you should be happy to leave your money invested for a few years but the longer the better.
Cash ISA
Cash ISAs are designed as a home for your cash savings.
We think it’s best to think of cash savings as money you’ll probably need to use in the immediate future (say within the next few years).
This could be your rainy-day fund or holiday savings, the main proviso is that you need to know the nominal value of your cash (i.e. its face value) won’t change, on paper your £1,000 will still be £1,000.
But while cash tends to hold its value in the short term, when it comes to growing your savings, keeping everything as cash is unlikely to be the best option.
Unless the interest rate you are getting on your cash is higher than the rate of inflation, left as cash, your money is likely to be worth less in the future. Your £1,000 won’t get you as far as it did a few years ago.
Given the higher levels of inflation we’re seeing at the moment, it could be a good idea to check in with your cash savings.
💡 More on saving vs investing.
Help to Buy ISA
A Help to Buy ISA is a type of cash ISA designed specifically to help first time home buyers save up for their mortgage deposit.
Help to Buy ISAs have been closed to new applicants since 2019. However, if you already had one at this point, you can keep contributing to it until 30 November 2029.
You can save up to £200 a month in a Help to Buy ISA and the government will pay a 25% bonus applied to the amount you’ve saved (up to a maximum bonus of £3,000) when you use your Help to Buy for a mortgage deposit.
The scheme is gradually being wound down which means you have until 1 December 2030 to claim the bonus. If buying a house is further away than this you could always transfer your Help to Buy ISA to a Lifetime ISA (see below).
It’s worth noting that because a Help to Buy ISA is a cash ISA you can’t contribute to both ISAs in the same tax year.
Lifetime ISA (LISA)
Lifetime ISAs were introduced to offer us a bit more flexibility when it comes to saving for the future.
Similar to Help to Buy ISAs, Lifetime ISAs are designed to help you save for your first house and can go towards your mortgage deposit. The government will also provide a 25% bonus to your contributions. But Lifetime ISAs aren’t exclusively for buying a home.
They can also be used to save for later life or retirement. With a Lifetime ISA, you can take money out of it from the age of 60.
Lifetime ISAs come with quite a few rules and regulations, including a specified value of the house you can buy with it. It’s definitely worth reading up on these before putting any money in.
If you decide you’d like to take your money out and it’s not to buy your first home or it’s before you are 60, you’ll pay a 25% withdrawal penalty (which takes back the 25% government bonus).
Innovative Finance ISA
Innovative Finance ISAs (IFISAs) are aimed at a set of investors known as ‘restricted investors’.
When you see this label, the investment behind it is most likely higher risk and aimed at those that understand the risk they are taking and can afford to withstand any losses.
Innovative finance ISAs don’t hold your everyday investments, they hold peer-to-peer loans which match up investors (those willing to lend) with borrowers (often businesses).
With peer-to-peer loans you lend directly, cutting out the bank - and this is where the potential for higher returns comes from. But it also means your investments might not be protected by the FSCS (like they would be with a cash or stocks and shares ISA). This means that if the platform were to crash (a few have in recent years) you’d lose your money.
How to choose the best ISA for you?
When thinking about which type of ISA to choose, it’s best to think about which one gets you closest to your goal.
What is your ISA for?
- Are you saving for the future but nothing too specific like a house deposit or retirement?
- Are you looking for an alternative to an everyday savings account?
- Are you looking to make more of your savings by investing?
- Do you need your ISA to be flexible in terms of what you can spend it on and when you can use it?
- Do you want to be able to hold cash and investments at the same time?
Depending on your answer, it’s likely one ISA starts to seem like a more obvious choice.
Remember too, you can mix and match your ISAs and spread your £20,000 ISA allowance across different types of ISAs.
Can you have more than one ISA?
Being able to mix and match ISAs shows that yes, you can have more than one ISA.
But there is a catch.
You can only open or add money to one of each type of ISA, in a tax year.
For example, you can add money to one cash ISA and one stocks and shares ISA in a year. But you can’t add money to two stocks and shares ISAs in the same year.
Transfer an ISA
Decided to postpone the round the world trip and invest the cash instead?
Not necessarily a decision many of us will face, but if we do, the good news is which ISA we have can change too (if needed).
Perhaps a cash ISA looked like the obvious option a few years ago but now a stocks and shares ISA looks closer to your investment goals.
Check with your ISA provider (or future ISA provider) first, but you can more often than not, transfer one ISA into another or to another provider.
This is often something used by those that have been on the ISA scene for a while and have collected a few different ISAs along the way. You could potentially transfer your ISAs to the same platform and keep them in one place.
The more rules an ISA comes with (e.g. a Lifetime ISA) the trickier it can be for transfers. Just check with your provider before you start.
If it’s a stocks and shares ISA you’re after, learn more about transferring your ISA to Freetrade.
Build your financial knowledge and be better positioned to grow your wealth. We offer a wide range of financial content and guides to help you get the insight you need. For example, learn how to invest in stocks if you are a beginner and make the most of your savings with ISA allowance or tax relief on pension contributions.
