Whether you’re a seasoned saver or are just getting started, you might already have, or know of, an Individual Savings Account – or ISA for short. ISAs can be a useful way of saving money for specific long or short-term goals that you have. But with multiple types to choose from and rules to consider, picking the right ISA to suit your needs might seem a little confusing.
In this article, we’ll cover some basics of how ISAs work, what types there are, and some examples of what people might use them for.
The information in this article is accurate as of 7 March 2024. Details are informative only and should not be taken as advice. If you’re unsure whether saving into an ISA is right for you, please speak to a financial adviser. There’s likely to be a cost for financial advice.
What is an ISA and how do they work?
An Individual Savings Account (ISA) is a form of tax-efficient savings or investment account. This means that you won’t personally have to pay income tax on any dividend income/ interest or capital gains tax on any growth you might make from the money saved in your ISA.
This means that you won’t personally have to pay Income tax on any interest earned from saving, or on any dividend income (money paid out by the companies you invest in, based on the current price of their shares). You also won’t have to pay tax on any growth if you sell or ‘dispose’ of any of your shares in a company – known as capital gains tax.
There are different types of ISA available, each with their own limitations, risk and flexibility. Certain ISAs might be considered more appropriate for different financial goals – such as buying a house, building a rainy-day fund or for long-term investing.
What types of ISA are there?
Currently there are four ISA types for adults in the UK:
However, in the 2024 Spring Budget, the Government announced a new ‘UK ISA’, which we’ll cover too.
Here’s a high-level introduction to each type of ISA.
1. Cash ISA
Cash ISAs are typically considered a low-risk way to save. When you pay into a cash ISA, your ISA provider (usually a bank or building society) will pay you tax-free interest on the money you save. Interest is paid either monthly or annually, depending on the ISA you choose.
You might receive a higher rate of interest if you commit to not touching your savings for a set period of time (often 1-2 years) – known as a Fixed-term ISA. Other cash ISAs could be more flexible – allowing you to access your money at any time, but typically with a lower or variable interest rate that can go up or down. You might want to keep track of your interest rate over time to make sure your money keeps pace with inflation.
What do people use cash ISAs for?
People use cash ISAs for both long and short-term saving. For example:
- To build up savings that can be accessed in an emergency, for example your boiler breaking down
- To save for a short-term goal, like buying a new car
- To earn tax-free interest on their savings over a longer term, but without the risk of investing
2. Stocks and shares ISA
In a Stocks and shares ISA, the money you save can be invested into funds, stocks, shares, bonds and other investments. Any potential gains made come from the performance growth of your investment, dividends paid by the company you invested in, or from the interest rates paid on your account. Your provider might charge an annual fee for managing the investments in your account.
Because your money is invested, a stocks and shares ISA comes with risk. The value of your investment can fall as well as rise and isn’t guaranteed, so you may get back less than you invest. You can choose how much risk you want to take by selecting individual funds to invest in. Or your provider might offer pre-made portfolios of investments to choose from, with lower to higher-risk options.
What do people use Stocks and shares ISAs for?
Because of the nature of investments, stocks and shares ISAs are typically designed for those looking to invest for a longer-term – usually a minimum of five years. The reason for this is that if investments perform badly, a long-term investor would have more time for their funds to potentially recover – but there’s no guarantee of this.
Here’s a few examples of why people might choose a stocks and shares ISA:
- They’re willing to take a higher risk for potentially higher returns (but there’s no guarantee of this as higher risk funds can also fall in value by large amounts)
- They want to save and invest for a longer period, in a tax-efficient way
- They want to support their income during retirement, either alongside or before accessing their pension savings
3. Lifetime ISA (LISA)
Lifetime ISAs (LISAs) were introduced in 2017 as a way to support first-time buyers or to save for retirement outside of a pension. A LISA can be either a cash LISA or a stocks and shares LISA.
A draw to LISAs for many people is the additional bonus from the Government. They add an additional 25% on top of what you save into your LISA each year (excluding any interest or gains from investments), up to a maximum of £1,000.
What do people use a LISA for?
We’ve already covered that LISAs are designed specifically for first-time buyers, or to access from the age of 60 as part of a retirement income. As such, you can only withdraw from your LISA for three reasons:
- To buy your first home (so long as it costs no more than £450,000)
- To make full or partials withdrawals without paying a fee, from the age of 60
- If you’re terminally ill with less than 12 months to live
If you make a withdrawal from your LISA for any other reason, you’ll face a 25% withdrawal charge.
There are also a couple of extra conditions to a LISA that differ from other ISA types:
- You can only open a LISA if you’re under 40 years old (and over 18)
- You can only pay a maximum of £4,000 into a LISA each year, up until the age of 50. The Government bonus also only applies to annual contributions up to age 50.
4. Innovative Finance ISA (IFISA)
Innovative Finance ISAs (IFISAs) are a little more complex, so we’ll only touch on them briefly. They’re designed for investors with a bigger appetite to risk.
Instead of cash or equities, IFISAs allow you to invest in peer-to-peer lending. This works like giving a small loan to a business or individual. You ‘loan’ or invest money on the basis of receiving a high rate of interest when the investment is repaid. The major risk is that the business or individual you’ve invested in can’t pay you back. This means you could end up losing some, or even all, of your investment.
It’s worth noting that IFISAs aren’t protected by the Financial Services Compensation Scheme. This is the scheme that protects customers of authorised financial services firms if they go out of business, offering compensation up to £85,000. This means if you have money in an IFISA with a company that goes out of business, you wouldn’t be entitled to any compensation through this scheme.
You can learn more about peer-to-peer lending through the Government’s MoneyHelper website.
5. The new ‘UK ISA’
At the 2024 Spring Budget, the Chancellor Jeremy Hunt revealed plans for a new UK ISA, to encourage investment in the UK economy. The proposal is that this ISA would be designed specifically to allow investors to invest in the UK in a tax efficient way and will have its own ISA allowance of £5,000. This would be on top of the existing current £20,000 ISA allowance (which we’ll cover in the next section). Before the ISA is launched, the Treasury will consult on the design and implementation of this new type of stocks and shares ISA.
How much can I save into an ISA?
Currently, you can save up to £20,000 into an ISA in a single tax year (6 April to 5 April) without facing a tax charge. You can choose to pay into a single ISA, or across the different ISA types. As part of your £20,000 allowance, only £4,000 can be paid into a Lifetime ISA.
When the UK ISA launches, you’ll be able to save a further £5,000 specifically into this ISA, which won’t count towards your £20,000 allowance. Note the design and implementation of this new UK ISA is pending official approval and so the saving limit and rules around the new UK ISA may still change.
An important rule change into how many ISAs you can save into each tax year will take place from 6 April 2024. The following section, ‘Can I have more than one of the same type of ISA?’, shares details of this.
Can I have more than one of the same type of ISA?
Currently, you’re allowed to have more than one ISA of the same type if they’ve been opened in different tax years. But you can only pay into one of each type in the current tax year (2023/24).
However, after 6 April 2024, the rules are changing, and you’ll be able to open and pay into multiple types of the same ISA each year. The exception to this will be the LISA where you’ll only be able to contribute to one LISA in the tax year.
Here’s an example to bring the changes to life.
Example using ISA rules before 6 April 2024
- Amy has been paying into a Cash ISA. She wants to open a second Cash ISA while still paying into her current Cash ISA.
- Amy can’t do this because the current rules state that she can’t pay into two of the same kind of ISA in a single tax year.
- Amy could wait until the next tax year and then open a new Cash ISA. Her existing Cash ISA would remain open, but she would only be able to pay into her new Cash ISA.
- Instead, Amy decides to open and start paying into a LISA, as she hasn’t yet paid into this type of account in the tax year.
- Amy is limited to paying in a maximum of £20,000 into her ISAs in the tax year, including a maximum of £4,000 into her LISA.
Example using ISA rules after 6 April 2024
- Amy has been paying into a Cash ISA. She wants to open a second Cash ISA while still paying into her current Cash ISA.
- As the rules have now changed, Amy is able to open the second Cash ISA and pay into both her Cash ISAs in a single tax year.
- Amy can still open and pay into other ISA types too.
- She is still limited to paying in a maximum of £20,000 into her ISAs in the tax year, including a maximum of £4,000 into her LISA.
The rules of ISA saving can be complicated – we recommend speaking to a financial adviser if you’re not sure. You can get help choosing a financial adviser on the MoneyHelper website.
Can I move money between my ISAs?
Yes – but this must be done by completing an ‘ISA transfer’ to protect the tax-free status of any income or gains you’ve earned. Here are the basics of moving money between ISAs:
- You can move your ISA from one provider to another at any time.
- You can transfer your ISA savings to the same type of ISA or to a different type of ISA (LISA rules apply).
- If the money you want to transfer has been invested in the current tax year, you must transfer all of it. However, this rule is changing from 6 April 2024, where partial transfers of contributions from the current tax year will be allowed.
- If the money you want to move was only invested in previous tax years, you can choose whether to transfer all or part of it – there may be a charge for transferring.
These are the most basic rules of transferring ISAs – but there are more complex rules and restrictions that might impact you. For example, transferring money out of a LISA before the age of 60 will incur a withdrawal fee of 25%.
Read the Government’s guidance on transferring your ISA to find out more information on restrictions when transferring an ISA, or speak to a financial adviser.
What ISA is right for me?
There’s no ‘right’ or ‘wrong’ ISA, but some ISA types might be more suited to you depending on your personal circumstances, financial goals and appetite to risk. Consider speaking to a trained, impartial adviser for guidance on what options may be best suited to your needs.
To help you picture your future self, try our Best life tool. Or if you need help setting and sticking to your goals, read our short article on 3 simple steps to help you hit your saving goals.