Savers and investors face a huge choice when it comes to putting their money into an ISA (individual savings account). The number of different ISA accounts has increased sharply over the last few years – which can make picking the right ISA for you a challenge.
It’s still possible to put money into a cash ISA – essentially a cash savings account with tax benefits – as well as into a stocks and shares ISA such as the Click & Invest Stocks and shares ISA, but there are also other types of ISA available, including those designed specifically for children or for people saving for their first home.
Each type of ISA can play a role in financial planning, and it can help to get independent financial advice when looking for the best way to grow your money. Under current rules you can save up to £20,000 in this tax year – which runs from 6 April 2018 to 5 April 2019 – into most ISAs, though there are lower limits for Help to Buy ISAs, Lifetime ISAs and Junior ISAs.
The tax advantages of ISAs may change in the future and also depend on your individual circumstances.
Learn more about ISAs and tax with our guide to the tax benefits of ISAs.
Types of ISA
The following are some of the main types of ISA available to UK residents. Of these, only stocks and shares ISAs are offered by Click & Invest.
- Cash ISA
A cash ISA is simply a deposit account that pays a certain rate of annual interest. The advantage of saving with a cash ISA is that there’s no income tax to pay on the interest your money earns.
For cash saved outside an ISA, income tax is liable on interest at the basic rate (20%), the higher rate (40%), or the additional rate (45%). However, basic rate and higher rate taxpayers have a personal tax allowance that lets them earn £1,000 or £500 a year respectively in non-ISA interest before income tax is payable.
Savers can choose between fixed-rate cash ISAs, where the interest rate is guaranteed for a period (usually between one and five years), and accounts with variable rates that may be changed by providers, usually in line with the Bank of England base rate.
Cash ISAs are good if you don’t want to risk getting back less money than you originally saved. However, with interest rates currently at historic lows, cash ISAs don’t offer the same potential to grow your money as a stocks and shares ISA. Over long periods, the buying power of the money in your cash ISA might be eroded by inflation.
- Stocks and shares ISA
Stocks and shares ISAs are a tax-efficient way to invest your money in the stock market and they offer the potential to generate greater returns than a cash ISA. You can invest money into company shares, corporate and government bonds, exchange traded funds (ETFs) or pool money in a fund with other investors to buy a range of assets. Any profit made from these investments is permanently protected from capital gains tax, which otherwise is currently levied at 10% for basic-rate taxpayers and 20% for higher-rate taxpayers.
Income generated by corporate bonds or company dividends within a stocks and shares ISA is also protected from income tax.
However, in a stocks and shares ISA (as with all investments) your capital is at risk and you could get back less than you originally invested. There are ways to mitigate that risk to an extent that you’re comfortable. One tactic is to regularly ‘drip feed’ money into a stocks and shares ISA, which smooths out the variance in share prices by buying some while they’re low and some while they’re high.
With some stocks and shares ISAs you’ll need to select the investments you want included in the ISA. Other providers, such as Click & Invest, offer ISAs where investments are actively selected, managed and monitored by experts, such as the Click & Invest Stocks and shares ISA.
- Help to Buy ISA
This is a type of cash savings account aimed at people looking to buy their first home. As well as the usual tax benefits, the government pays a 25% top-up to Help to Buy ISA holders, on the condition that the money in the account is used as part of a deposit on a new home.
Different limits apply to this type of ISA: savers can deposit as much as £1,200 in their first month and up to £200 a month thereafter. The maximum total contribution is £12,000 over several years. After 30 November 2019, Help to Buy ISA providers will no longer be offering this product to new customers.
A stocks and shares ISA can be used alongside a Help to Buy ISA as part of a broader investment strategy for first time buyers, as you can normally use the unspent portion of your £20,000 to invest in a stocks and shares ISA.
- Lifetime ISA
The Lifetime ISA was introduced in April 2017 to help those aged between 18 and 40 to either save for a property deposit or for their retirement. Cash or stocks and shares can be held in a Lifetime ISA with the normal tax-free benefits. As with a Help to Buy ISA, there is a 25% government bonus available – provided the money is used for a first home deposit or withdrawn after you turn 60.
Up to £4,000 a year can be saved into a Lifetime ISA, and this counts towards your overall £20,000 annual ISA allowance. Saving in a Lifetime ISA means you can still invest any unused ISA allowance in a different ISA.
- Other ISA accounts
Other ISA accounts include the Innovative Finance ISA, which allows loans made through online peer-to-peer lending platforms to be sheltered from tax – in this case, the interest repaid by borrowers is not subject to income tax. Junior ISAs are cash or stocks and shares accounts aimed at children, with an annual savings limit of £4,260 (2018-19), although this will rise to £4,368 from April 2019. The money in a Junior ISA is effectively locked away until the child turns 18.
How to pick the perfect ISA
While certain ISAs are suitable for specific financial goals – such as buying your first home – it pays to consider which type of ISA best suits you. From knowing how much you can invest to investing over the longer term, picking the perfect ISA means having a plan in place.
- Know the ISA limits and ISA deadline
Your ISA limit expires at the end of each financial year on 5 April. Any portion of your £20,000 that is left unused is lost when the new year’s ISA allowance kicks in, so you need to act before the ISA deadline. You cannot roll over any unspent allowance from a previous year. In the 2018-19 and 2019-20 tax years, the ISA limit is £20,000 per person per year. This limit can be shared among different types of ISA, or invested entirely in a stocks and shares ISA or a cash ISA. If you were to use up your entire £4,000 Lifetime ISA allowance, for example, this would mean you would have £16,000 left to put into other types of ISA.
- Know your financial goals
Some ISAs are designed for a specific financial goal. For example, a Lifetime ISA is only suitable for you if you’re planning to buy a home, or saving for retirement. You’ll lose out on the government bonuses if you withdraw you money for any other reason, so that’s something you’ll need to be sure about before you open your account.
For other financial goals, you’ll need to think about how long you plan to leave your money in an ISA, and whether you might need access to it at short notice, as different ISAs have different rules on this.
- Investing for the medium- to long-term
The right type of ISA for you will often depend on your savings or investment goals and time frame. But if you can afford to leave money invested for at least three years, a stocks and shares ISA may be worth considering.
While investing carries more risk than holding cash, it also offers better growth potential that saving over the long term.
Holding investments over longer periods gives your capital the chance to ride out fluctuations in value that are considered normal in stock markets. To see how much your tax-free ISA holdings may be able to grow, look at Click & Invest’s Investment Calculator to see a range of possible investment projections.
A key consideration is your appetite for risk and your capacity for financial loss – especially when choosing between a cash ISA and a stocks and shares ISA. Click & Invest has a unique questionnaire to help determine your attitude to risk, which it uses to assess whether one of our stocks and shares investment strategies is suitable for you.
With investment your capital is at risk. The tax advantages of ISAs may change in the future and also depend on your individual circumstances.
This article is not intended to constitute personal advice and no action should be taken, or not taken, on account of information provided. Opinions given within this article are the speakers’ own personal views. The views and opinions are effective from the date of publication but may be subject to change without notice.