What is an ISA?

ISAs offer you a flexible way to save or invest without paying any tax on the interest or profits you earn. Our simple guide explains the basics of how they work, what types of ISA are available and how ISAs compare with regular savings accounts.

ISAs offer you a flexible way to save or invest without paying any tax on the interest or profits you earn. Our simple guide explains the basics of how they work, what types of ISA are available and how ISAs compare with regular savings accounts.

Anelda Knoesen
From the Money team
6
minute read
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Posted 28 MAY 2021

What is an ISA?

ISA stands for individual savings account. Put simply, it’s a savings or investment account that you never pay tax on.

There are limits set by the government on how much you can save or invest into an ISA account in the UK each year. This is called your ‘ISA allowance’. The exact amount can change each tax year.

ISAs are offered by a range of financial institutions, including banks, building societies, the Post Office, insurance providers, stockbrokers and peer-to-peer lenders.

How do ISAs work?

Your money can’t be taxed when it is in an ISA, no matter how long you keep it in there.

You’ll get a new ISA allowance at the start of every tax year. This is how much you can pay into an ISA. For the tax year 2021/2022, the maximum amount you can put in is £20,000. The tax year runs from 6 April to 5 April.

If you don’t use all your ISA allowance before the end of the tax year, you’ll lose it forever. You can’t roll it over to the next year.

To open an ISA, you’ll need to be at least 16 years old and a UK resident. You can set up an ISA account online, in-branch, by post or over the phone, depending on which product you choose.

You can have more than one ISA, but the allowance applies across the total of all accounts. You can put the full £20,000 into just one account or split it across various types of ISA. You cannot pay into two ISAs of the same type in the same tax year.

Who can open an ISA?

To open an ISA, you must be a resident of the UK and: 

  • 16 or over for a cash ISA 
  • 18 or over for a stocks-and-shares or innovative-finance ISA 
  • Between 18 and 40 for a Lifetime ISA 
  • Under 18 for a Junior ISA 

Only individuals can open an ISA. You can’t hold a joint ISA with someone else – even your spouse or civil partner – or on their behalf.  

How do you open an ISA?

Opening an ISA is a very simple process. As it’s not a credit product, there’s no credit check to worry about. You won’t have access to an overdraft or be able to borrow against it, so it won’t affect your credit score.

Most providers let you open an ISA in person at a local branch, over the phone, by post or online. Some ISAs can only be managed in a particular way, so you’ll have to do it all online or all in a branch – so make sure you pick what’s convenient for you. All you’ll need is proof of ID, including your address, and National Insurance Number. You’ll also need a valid email address if you’re opening an ISA online.

In some cases, you can open a cash ISA with as little as £1, although some will require a minimum deposit of £100.

What types of ISA are there?

ISAs come in different forms and can help you save for different things, such as a home, for retirement or for your children’s future:

  • Cash ISA – works much like a regular savings account except the interest you earn, however much it is, isn’t taxed
  • Lifetime ISA – designed to help young people under 40 save for the future, and benefit from a 25% government bonus of up to £1,000 a year
  • Stocks and shares ISA – lets you invest your allowance in shares and bonds
  • Innovative finance ISA – peer-to-peer lending, which allows you to invest your money to lend to borrowers or businesses
  • Junior ISA – save tax-free on behalf of your child until they turn 18

Some types of ISA are riskier than others, but may have potential for higher profits – or losses.

Did you know?

The government’s Help to Buy ISA closed on 30 November 2019 and new applicants can no longer apply. Much like the Lifetime ISA, it’s designed to help first-time buyers save for a house deposit. Account holders with at least £1,600 in savings can benefit from a 25% government bonus up to a maximum of £3,000. If you opened a Help to Buy ISA before the cut-off date, you can still continue saving into your account up until November 2029.

What is a cash ISA?

A cash ISA is much like a regular savings account, except that the interest earned is never taxed. The minimum amount you’ll have to deposit to open your account can vary from £1 up to £1,000.

Interest rates vary between providers and you can choose between:

  • an instant-access cash ISA – you can pay in and take out money as often as you like, although some ISA accounts do have limits on this. The interest rate is usually variable, which means it can go up or down.
  • a fixed-rate cash ISA – you deposit money and agree to lock it away for a fixed length of time, five years, for example. Generally, the longer you tie up your money, the higher rate of interest you’ll earn. There are usually penalties if you try to access your money before the end of the fixed-rate period.

You must be aged 16 or over to open a cash ISA savings account, and you’re only allowed to pay into one cash ISA in each tax year. You can transfer an existing cash ISA to a new provider at any time without losing your tax-free benefits. To keep the tax-free status of your money, you’ll need to contact your new provider and arrange a transfer, rather than withdrawing the money and opening a new account.

What is a Lifetime ISA?

A Lifetime ISA (LISA) is available to anyone aged 18 to 39. You can use it to buy your first home or save for your retirement.

You can save up to £4,000 a year until the age of 50, and you’ll receive a 25% bonus from the government on top of what you pay in. Potentially, that could give you an extra £1,000 a year.

There’s a penalty to pay, though, if you withdraw the money before your 60th birthday or you don’t use it to buy a house.

What other types of ISA are there?

Compare the Market currently only offers comparisons for cash and Lifetime ISAs, but there are other types of ISA available:

Stocks and shares ISAs 
Stocks and shares ISAs give anyone over the age of 18 the chance to invest in the stock market through funds, bonds and individual shares. You’ll usually need to invest a minimum of at least a £100 lump sum or £25 a month, but this can vary considerably between providers. You won’t pay tax on any profits or dividends you receive.

Your money is more at risk than with a cash ISA, but you could get better returns. These types of ISAs are usually most suitable for people who are willing to invest for at least five years, as the value of the investment will go up and down and you could get back less than you put in.

Innovative finance ISAs 
Innovative finance ISAs (FISAs) allow you to earn tax-free interest through peer-to-peer lending, where you act as the lender. They can be more lucrative than cash ISAs, but they’re also riskier as there’s a chance the borrower might not pay back the loan. You need to be over 18 to get this type of ISA.

Junior ISAs 
Junior ISAs are for children under the age of 18. You can save up to £9,000 in each tax year on behalf of your child. They can’t access their ISA savings until their 18th birthday. It’s possible for a 16- or 17-year-old to have both a Junior ISA and a cash ISA.

What do I need to know before opening an ISA?

There are a few things to consider before deciding which ISA is right for you.

Before you open an ISA, think about:

  • Access – think about the money you want to save. If you want an emergency pot that you can dip into at any time, an easy-access cash ISA might work well. Just be aware that some providers limit the amount of withdrawals you can make, so read the terms and conditions before you commit. If you have a long-term savings goal and you’re happy to lock your money away for a while, fixed-term ISAs can usually offer a higher interest rate. Just be aware that you could be penalised if you try to get your money out before the term is up.
  • Flexibility – many ISA deals let you take your cash out and top it back up again in the same tax year without it affecting your ISA allowance. The current allowance is £20,000. Let’s say you put £10,000 into your ISA during the 2021/2022 tax year. You then take £5,000 back out. If your ISA is ‘flexible’, you can still deposit up to £15,000 during the same tax year rather than just £10,000 (your remaining allowance if your ISA isn’t flexible). If you think you might want this option, check which ISAs are ‘flexible’ when comparing deals. Many older ISAs don’t have this option, so don’t take cash out before you’re sure about your options.
  • Fixed or variable interest – variable ISAs mean that the interest can go up or down. This is often the case with easy-access accounts. Your provider should tell you in advance if your interest rate will be cut, but it’s a good idea to keep an eye on it and consider switching if it goes too low. If you want the certainty of knowing your interest rate won’t change while it’s locked away, a fixed-rate ISA might be a better option.
  • When and how is interest paid? – some ISAs pay interest monthly, while others pay annually. Some providers may insist the interest is paid into another account, while others want you to pay the interest back into the ISA to help it grow. And there are some that even give you the choice.
  • Transfers – if you’re comparing cash ISAs with similar rates and you want to transfer ISAs from previous years to keep it all together with one provider, check to see if this is possible. Not all cash ISAs will accept transfers.

It’s important to read the terms and conditions so you know how your ISA works before signing up. That way, you can work out which type of account can benefit your personal circumstances the most.

Frequently asked questions

What is the difference between an ISA and a savings account?

It’s important to understand the differences between an ISA and a traditional savings account so you can decide which one would suit you best:

  • Tax – the most obvious difference is how much tax you’ll pay on your savings. With a savings account, you may have to pay income tax on the interest you earn. However, you do get a personal savings allowance. This means that basic taxpayers (20%) can earn up to £1,000 in interest a year before they have to pay tax, while higher taxpayers (40%) can earn up to £500. For most people, this means all their savings will be tax-free. An ISA is totally tax-free, no matter how much interest you earn. Remember, it’s always possible for the government to change the savings allowance, but it would be highly unlikely that they would change the tax status of an ISA.
  • Savings limits – unless there’s a limit set by your bank or building society, you can put as much money as you like into a savings account. With an ISA, you’re given an ‘allowance’, so you can only deposit up to that amount each tax year. The current ISA allowance is £20,000.
  • Number of accounts – although you can have more than one ISA, you can only open one cash ISA each tax year. You can open as many savings accounts as you like, when you like.
  • Account holders – An ISA is an ‘individual’ savings account, so it can only be opened in one person’s name, whereas you can open a [joint savings account ]<link to new page: SA_5598 Joint savings accounts> with another person, such as your partner or spouse.
  • Flexibility – ISAs give you flexible savings options, as you can invest in cash, stocks and peer-to-peer lending. Some cash ISAs may also pay higher interest rates than equivalent savings accounts, so it’s always worth comparing the two.
  • Government help – If you’re a first-time buyer under 40, a Lifetime ISA can be a better option than a savings account, as you get a 25% bonus from the government. This could be a real bonus if you’re trying to save for a mortgage deposit.

How much tax can I save with ISAs?

You won’t have to pay income tax or capital gains tax on an ISA, which means it’s one of the most tax-efficient ways to save. The amount you’ll actually save on taxes depends on your individual circumstances and how much you have in your ISA accounts. Thanks to the introduction of the personal savings allowance, most people won’t pay taxes on their regular savings accounts. So, it has to be said that the tax benefits of cash ISAs aren’t as great as they once were.

If you’re an ISA account holder in the higher tax bracket (40%), you may find an ISA more tax-efficient than regular savings or share-based investments. With a savings account, you’d have to pay income tax on any interest you earn over £500. If you own shares, you’d have to pay tax on any dividends over £2,000; for higher taxpayers, it’s 32.5% in the current tax year of 2021/2022. With an ISA you don’t have to pay any tax at all.

What happens if I go over my ISA allowance?

If you’re juggling several ISAs between different providers, there’s a risk that you could go over your ISA allowance during a single tax year.

If you think you’ve gone over your allowance limit, contact the HMRC savings helpline. They will tell you what to do next. If it’s a genuine mistake and the first time it’s happened, you may be let off with a warning letter. But if HMRC decides to take action, any savings and related interest earned above your allowance could be taxed. HMRC will see you’ve paid in too much money from your records at the end of the tax year, so, it’s best to tell them as soon as you realise your mistake.

Can I carry any unused allowance over to the next tax year?

No. Any unused allowance can’t be carried over to the next tax year. The ISA allowance will be reset back to the yearly limit again on 6 April – the beginning of the new tax year.

How many ISAs can I have?

You can have as many ISAs as you like, but you can only open one new cash ISA in each tax year. So, if you open a cash ISA this year, you’ll need to wait until 6 April next year to open another one.

Your ISAs can be a mixture of cash, IFISAs, stocks-and-shares ISAs and Lifetime ISAs. But you can only put money into one of each kind of ISA during the same tax year. So, if you have two cash ISAs, you can only make a new deposit into one of them in the current tax year.

Also, bear in mind that if you have more than one ISA, your allowance is combined – you don’t get a separate £20,000 allowance for each ISA. You can choose to put the full allowance in one single account, or you can spread it over different accounts, as long as you only choose one of each kind of ISA for the current tax year.

Can I withdraw money from my ISA and put it back later?

Yes, but only if you have a flexible ISA. A flexible ISA lets you take out money then put it back in without it affecting your yearly allowance. The only condition is that you must replace the amount you took out before the end of that same tax year. If you want this option, then be sure to look for flexible ISAs when comparing deals.

Can I transfer my ISA?

If you find a better deal somewhere else, then you can transfer your ISA to another provider at any time.

However, if you want to transfer money that you invested into your ISA during the current tax year, you’ll need to transfer all of it. If it’s money that you invested in previous years, you can choose to transfer all, or just part of it.

Before you transfer, find out if there are any restrictions or charges. For example, if you want to transfer money from a Lifetime ISA into a different ISA before you reach the age of 60, you’ll have to pay a 25% withdrawal fee.

To switch providers, you’ll need to contact your new provider and fill out an ISA transfer form. Don’t just withdraw your money without filling in the form. If you do, you won’t be allowed to reinvest that part of your tax-free allowance in the same tax year.

How are ISAs protected?

Just like all UK-authorised bank accounts, ISAs are protected under the Financial Services Compensation Scheme (FSCS). Savings up to £85,000 per person, per bank, are protected if the bank goes bust. If this happens, you’ll be automatically compensated by the FSCS.

What happens to my ISA if I die?

If you die, your ISA will lose its tax-free status. If you leave more than £325,000 in assets, your ISA will be subject to inheritance tax along with the rest of your estate. The only exception is if it’s inherited by your spouse or civil partner. In this case, there’ll be no inheritance tax to pay and your spouse or civil partner can move the ISA into their name. This is called additional permitted subscription. As well as the balance of your ISA, they’ll also inherit your allowance on top of their own £20,000 allowance.

If you leave your ISA to someone else, for example your son or daughter, your spouse or civil partner will still benefit from the additional £20,000 allowance.

How can I check how much of my ISA allowance I’ve used?

Contact your ISA provider, as they’ll be able to tell you how much you’ve saved in the current tax year. You can also find out by logging on to your online account, if you have one.

Will an ISA affect my benefits?

An ISA could affect you if you’re on means-tested benefits such as Universal Credit, Housing Benefit or Income Support. If you have over £6,000 in savings, you need to tell the benefits office as it could affect how much you receive. If you have more than £16,000 in savings, you’ll no longer be eligible for means-tested benefits.

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