An Individual Savings Account (ISA) is a tax-efficient way to save money. As we move forward into the new financial year 2017 – 2018, there is a new ISA allowance of £20,000. There are two types of ISA: Cash and Stocks and Shares and you can split your allowance between the two types. If you’re already paying into an ISA, you might want to consider increasing your direct debit payments. It’s worth noting that you cannot sign up to more than one type of ISA during a tax year, but you can transfer from one type of ISA to another.
If you are unsure on which ISA to choose, we have pulled together a list below to help you choose the right option for you and your situation:
Basically, a cash ISA is a simple savings account. Any interest you receive on your savings is tax-free and the interest does not count towards the ISA allowance. This means you can effectively protect your money from tax. There are various types of cash ISA available including flexible cash ISAs and easy-access ISAs just like ordinary bank accounts. Of course, the less your money is tied-in, the lower the interest rates will be and it’s hard to find good rates at the moment. Try to avoid a cash ISA that you can’t get money out of quickly, even if that does mean you will lose a bit of interest. Some ISAs are marked as ‘flexible’ cash ISAs and these allow you to withdraw money and then pay it back in during the same tax year without it counting towards the ISA allowance again. All cash ISAs may have either variable or fixed interest rates. To open one, you need to be over 16 and a UK resident.
Stocks and shares ISA
A stocks and shares ISA allows you to invest your money into individual company shares, investment funds, corporate bonds and government bonds. But that doesn’t have to mean you are taking lots of risk with your money. Investments in a stocks and shares ISA can range from only slightly riskier than cash right up to the very highest levels of risk. So don’t let the idea of investing put you off if it’s not something you have considered before.
Once your money is within a stocks and shares ISA, there is no capital gains tax on profits from investment growth and no tax on interest earned on bonds or dividend income. Managed by a fund manager and usually available online, there is usually a fee for opening this type of ISA and possible charges for withdrawing or moving your money. There is an element of risk here, as your investments may go up and down over time, so this type of ISA should be considered as a long-term strategy (at least 5 years). Depending on the provider, you might be able to split your annual allowance between a cash ISA and a stocks and shares ISA. To open this type of ISA, you need to be over 18 and resident in the UK.
Innovative finance ISAs
Started in 2016, this recent type of ISA works as peer-to-peer lending, enabling people and companies to lend cash to other businesses, as well as property and crowdfunding. Credit checks and repayments are managed by a large-scale online website. Although there are very attractive rates for savers, this should be considered as an investment rather than a savings account, because there is always a risk that the borrower won’t repay the money. Any interest gained from lending money to others is not taxed but, similarly to the stocks and shares ISA, this should be considered as a long-term strategy and you need to have a solid financial buffer behind you in terms of managing the level of risk.
Lifetime ISAs (LISA)
Launched on 6 April 2017, this new type of ISA is designed to help younger people to save for their retirement and to get onto the property ladder. Savers can put £4,000 into a LISA every year tax-free, and the government adds a 25% annual bonus – e.g. £4,000 will become £5,000. A LISA can comprise of either a cash ISA or a stocks and shares ISA, but the bonus will only apply to contributions, not any interest gained on stocks and shares. Once the bonus reaches £32,000 it will cease, and you will only be able to save into this type of ISA until you reach 50. To open a Lifetime ISA, you need to be aged between 18 and 39. There is some doubt as to whether these types of ISA will be around for long as they have not been well-received.
Although in this article we have focused on ISAs suitable for adults, there are also Junior ISAs available for children – see our recent blog on children’s savings strategies.