Cash ISAs are by far the most common type of ISA, accounting for 72% of all ISAs paid into in the previous tax year (2017/18) . But what makes them so popular? Are they the best type of ISA for saving, or just the most well-known?
What exactly is an ISA?
An ISA is an individual savings account. If you live in the UK for more than 183 days a year (a UK resident) you have the option to deposit your money in an ISA account and benefit from tax breaks on up to £20,000 (2018/2019). These breaks include tax-free interest on cash savings and no income tax, dividends tax or capital gains tax on stocks and shares.
For those under the age of 18, there are also a range of Junior ISAs available (including stocks and shares ISAs).
ISAs were introduced in 1999 by the British government, replacing TESSAs (Tax Exempt Special Savings Accounts). They are put in place to encourage long-term saving. Having an ISA account could be a sensible decision if you would like to keep more of your savings by benefiting from tax breaks.
There are different types of ISAs, designed to offer a helping hand for different goals, such as buying a first home or starting a business. If you are saving your money with a future goal in mind, whether that could be a dream holiday or retirement day-to-day living, it could be worthwhile to look into your ISA options to see if you can hit your goal sooner.
At the time of writing (2018/2019), the following ISA accounts are available:
For those under 16:
For those aged 16 or over:
For those aged 18 or over:
Junior cash ISA
Stocks and shares ISA
Junior stocks and shares ISA
Help to Buy ISA
Innovative finance ISA
If you’re trying to decide which type of ISA is best for your needs, here are some of the key facts and things to consider about the four main types.
A cash ISA is a tax-efficient savings account. It is very similar to a high street savings bank account or building society account, but with the added bonus of having tax breaks on interest gained (within the annual allowance).
Who are cash ISAs for? To be eligible for a cash ISA you must be a UK resident over the age of 16.
How do cash ISAs work? The ISA holder pays in as much or as little as they want (subject to the personal ISA allowance). They will typically earn a small amount of interest (0-2.3% , paid on a monthly or yearly basis.
What are the tax benefits? Any interest generated by the ISA is free from income tax. Whereas usually interest generated above the personal savings allowance of £1,000 would be taxed as income at your marginal rate.
Are there different types of cash ISA? Yes, there are several different types, of which you can choose one:
Easy-access cash ISAs allow you to withdraw money when you need to without paying a penalty.
Fixed-rate cash ISAs usually offer a slightly higher interest rate than easy-access cash ISAs, if you’re willing to lock your money away for a set period (often one, three or five years). If you make a withdrawal before the agreed time you’ll often pay a penalty.
Flexible cash ISAs allow you to withdraw money when you need to, and replace it in the same tax year, counting against your ISA allowance just once.
What are the advantages of a cash ISA?
- Compared to any other type of cash savings account, the advantage of an ISA is the tax benefits.
- Compared to other types of ISA, a cash ISA is typically the easiest account to make a withdrawal from.
Are there any drawbacks to a cash ISA?
- Cash ISAs offer limited returns as they only generate a small amount of interest.
- If the interest rate on your cash ISA is outpaced by inflation, the value of your ISA in real terms will fall as time goes on.
What should you consider before getting a cash ISA?
When comparing cash ISA providers, some things to look at are:
- the interest rate they offer,
- any fees they charge,
- whether it’s a flexible ISA,
- any other restrictions on your access to your money.
All of these factors can impact the returns you get on your ISA. The right choice for you will depend on how long you’re prepared to lock your money away for, and whether or not you might need access to it.
Stocks and shares ISAs
The type of ISA we offer at Click & Invest is a stocks and shares ISA - a tax-efficient account that can hold a variety of different investments.
Who are stocks and shares ISAs for? To be eligible for a stocks and shares ISA you must be a UK resident over the age of 18.
How do stocks and shares ISAs work? The ISA holder pays into an investment account in order to buy whichever investments can be held in that account type, which may include equities, bonds, gilts, property and alternatives. Buying and selling investments can generate a profit, and some investment might generate interest or dividends.
What are the tax benefits? Any interest generated by the ISA is free from income tax. Any dividends received are free from dividends tax, which usually applies above a £2,000 allowance. And any capital gains (returns generated by buying and selling investments) are free from capital gains tax, which usually applies above a £11,700 tax-free allowance.
Are there different types of stocks and shares ISA? Yes, there is a lot of variance between the product and service offered by different stocks and shares ISAs. Here are a few examples:
Like cash ISAs, stocks and shares ISA can be flexible or non-flexible. With flexible ISAs, you can move money in and out of your ISA account without affecting your annual allowance. While some providers, such as Click and Invest offer flexible ISAs, others do not, so it is worth checking.
Some are limited in the type of investments you’re able to hold. For example, some stocks and shares ISA are only invested in property funds – these are sometimes called property ISAs. Some will only give you access to passive investments, such as exchange traded funds (ETFs). At Click & Invest, the portfolios are globally diversified as our in-house research team scrutinise tens of thousands of opportunities to find the best-suited ones for each investment strategy.
Some stocks and shares ISAs allow you to build your own portfolio of investments, which you choose yourself. This is sometimes referred to as “DIY investing”. Others offer ready-made portfolios, also known as “managed accounts”. For example, The Click & Invest Stocks and shares ISA is managed by experts, so it is a managed account. This means that you benefit from all the advantages of being an investor, with none of the hassle
What are the advantages of a stocks and shares ISA? Stocks and shares ISAs offer better growth potential than cash ISAs, and are suitable for a wide range of investing goals (compared to Help to Buy ISAs or Lifetime ISAs, which we’ll come on to).
What are the disadvantages of a stocks and shares ISA? As with all investment, your capital is at risk, and you may get back less than you put in. Also, the fees for a stocks and shares ISA are typically higher than a cash ISA, due to the higher associated costs. Stocks and shares ISAs are not usually recommended if you’re likely to make a large withdrawal within three years, due to the potential fluctuations in value linked to the stock markets.
What should you consider before getting a stocks and shares ISA? First it’s important that you fully understand and are prepared to accept the risks associated with investing. You should look for an ISA that offers you the ability to hold the type of investments you would like to, and the right level of control or support when it comes to making investing decisions.
You may also want to consider whether you would prefer to have an active or passive account. Passive accounts tend to invest in exchange traded funds, which means that your investments go up and down at the market rate. Actively managed accounts are more hands-on, where experts scrutinise the market to look for the investments which they believe will outperform the market. To learn more about the differences between active and passive investing, here is a useful explanation
If you’d like to learn even more, read about the rules of stocks and shares ISAs.
A Lifetime ISA is a relatively new type of ISA that’s intended to help you save for your first home or for retirement.
Who are Lifetime ISAs for? To be eligible to open a Lifetime ISA you must be a UK resident between 18 and 40. Once you have turned 40 you cannot open a Lifetime ISA but you can continue to pay into an existing Lifetime ISA until you are 50.
How do Lifetime ISAs work? Lifetime ISA holders can pay in up to £4,000 in each tax year (though this amount could change in future), subject to the ISA allowance. The government adds a 25% bonus to each payment. The money can either be used to buy a first home, or withdrawn after the age of 60. It can also be withdrawn in the case of a terminal illness diagnosis with less than 12 months to live. If it is withdrawn for any other reason, a 25% penalty must be paid to the government.
What are the tax benefits? As well as the government bonus, Lifetime ISAs offer the same tax benefits as other ISAs.
Are there different types of Lifetime ISA? Yes, Lifetime ISAs are available as both cash ISAs or stocks and shares ISAs. Each eligible person may only have one type.
What are the advantages of a Lifetime ISA? The government bonus could help you to increase the value of your Lifetime ISA much faster than another type of ISA, if buying a first home or saving for retirement is your main goal.
What are the disadvantages of a Lifetime ISA? The limitations on withdrawals from a Lifetime ISA mean that they are not suitable for everyone. If you open a Lifetime ISA but later need to withdraw your money for a reason not allowed by the Lifetime ISA rules, you’ll receive back less than you put in.
What should you consider before getting a Lifetime ISA? You should be sure that you intend to use the money for one of the specific purposes of a Lifetime ISA, and that you are eligible to do so. You’ll also need to decide whether a cash or stocks and shares account is better suited to your needs, based (among other things) on how long you have until you’ll be buying a house.
If you need more help with this decision, read our guide: cash ISAs vs stocks and shares ISAs.
Innovative finance ISAs
Innovative finance ISAs offer tax benefits on peer-to-peer lending.
Who are innovative finance ISAs for? To be eligible for an innovative finance ISA you must be a UK resident over the age of 18.
How do innovative finance ISAs work? If you would like to lend money through an FCA-regulated peer-to-peer lending platform, an innovative finance ISA allows you to do so without paying income tax or capital gains tax on any returns you receive. These lending platforms are a new way of borrowing and lending outside of the traditional banking system, and include website like FundingCircle and Zopa.
What are the tax benefits? Usually interest you earned through this system of lending would be taxed as income if it exceeded your personal savings allowance. The innovative finance ISA ensures that it is not.
Are there different types of innovative finance ISA? Yes, they vary based on the loan types they offer (e.g. property, business or consumer) and the length of the loan period.
What are the advantages of an innovative finance ISA? The target returns advertised for innovative finance ISAs are a lot higher than other types of ISA, ranging from 3.54%-12% for top providers .
What are the disadvantages of an innovative finance ISA? Usually you lend your money for a fixed term, so an innovative finance ISA may not be suitable if you want flexible access to your money. These ISAs are higher risk than other types.
What should you consider before opening an innovative finance ISA? You should have a good understanding of peer-to-peer lending and the risks involved. Innovative finance ISAs are not protected by the Financial Service Compensation Scheme (FSCS). It can be difficult to compare rates offered by different providers as the rates are not guaranteed and your returns may be less, or more, than advertised. You should remember that you may not have access to your money for a period of months or years and there may be a fee if you withdraw early.
Now that you know in a bit more detail about the six main types of ISA, perhaps you have a clearer idea of which one you need. So if you decide on a cash ISA, it’ll be because of the great advantages offered by that account type, and not because you don’t know enough about your options.
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.