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ISA is short for Individual Savings Account and allows you to earn interest tax free, but you’re limited to how much you can put in each year.

ISAs, or individual savings accounts, can help you build up a pot of money that you’ll never pay tax on. Here’s a rundown of the different types of ISA available and how to find the best rates.

What is an ISA?

ISAs allow you to save or invest a certain amount each year without paying tax on any interest or capital gains you earn.

Each tax year you have an annual allowance for how much you can put in an ISA. For 2020-21 the ISA allowance is £20,000. The tax year runs from 6 April to 5 April the following year.

If you don’t use all your ISA allowance in the same tax year, it can’t be rolled over to the next year. You use it or lose it.

How do ISAs work?

There are four main types of ISA – cash ISAs, stocks and shares ISAs, innovative finance ISAs and Lifetime ISAs. You can save up to £20,000 in one type of account or split your allowance across some or all of the other types. But you’ll need to make sure you stick to all the rules so you don’t lose the tax advantages.

  • The maximum amount you can add to a Lifetime ISA is £4,000 a year.
  • Cash ISAs work in much the same way as regular savings accounts. Interest rates vary between providers and you can choose between instant access or fixed-rate ISAs. With a fixed-rate ISA, your money is tied up for a fixed term. You’re only allowed to open one cash ISA in each tax year.
  • Stocks and shares ISAs allow you to invest in the stock market through funds, bonds and individual shares. You won’t have to pay tax on any profits or dividends. While investments are riskier than cash, shares typically outperform cash over the long term so they could give you better returns. Always remember, though, that the value of your investments can go down as well as up and that how they’ve done in the past isn’t a guarantee of how they’ll perform in the future. This all means that you could get back less than you paid in.
  • Innovative finance ISAs enable you to earn tax-free interest through peer-to-peer lending. Essentially, you take on the role of a bank by lending to individuals, businesses or property developers through an online platform. It can give you higher returns than a cash ISA but it’s also riskier as there’s a chance the borrower could default on their loan, so you may get back less or even lose what you had invested.
  • Lifetime ISAs are designed to help young people save up for either a deposit on their first home or for their retirement. You can open one if you’re 18 or over and under 40, and you can save up to £4,000 a year up to the age of 50. You’ll get a 25% bonus from the Government every year you make a deposit. However, you can only withdraw from a Lifetime ISA if you’re buying your first home, or if you’re over 60 years old, or are terminally ill with less than 12 months to live. Otherwise there will be a withdrawal charge.

Which is the best ISA for me?

This really depends on what you’re saving for and your attitude to risk. A cash ISA may be more appealing to a cautious saver who wouldn’t want to risk losing their money. Cash ISAs in the form of an instant access account may be an option if you’re saving for a short-term goal or need access to your cash in an emergency. The downside is that interest rates tend to be very low. Stocks and shares ISAs and innovative finance ISAs are riskier, but they could give you better returns than cash over the long term.
 
If you’re an adult under 40 and saving to buy your first home, a Lifetime ISA could be worth considering as you get a 25% bonus, up to a maximum of £1,000 a year – basically free money for saving. However, you’ll have to pay a penalty if you withdraw the money for something other than a property deposit or retirement. 

Frequently asked questions

Who can open an ISA?

Cash ISAs are open to any UK resident aged 16 or over. To hold a stocks and shares or innovative finance ISA, you must be at least 18. Lifetime ISAs are open to adults aged 18-39 inclusive.

How do I switch ISAs?

If you’re not happy with your current ISA rate, you can switch providers. Never take out the money yourself as you’ll lose your tax benefits. Your new provider should be able to take care of the switch for you. A cash transfer should take no longer than 15 working days. If you transfer a stocks and shares ISA, it should take no more than 30 calendar days.

Can I get an ISA for my children?

Yes. You can open a Junior ISA on behalf of your child. Money deposited in the account belongs to the child, but they can’t withdraw it until they turn 18. Junior ISAs have a lower annual limit than adult ISAs at £9,000 for the 2020/21 tax year, but you can usually get better interest rates.

How do I find the best ISA rates?

If you think you’re unlikely to need access to your savings in the short term, consider a fixed-rate ISA. These usually offer better interest rates than instant-access ISAs. The longer you’re willing to put your money away for, the better rate you’re likely to get. To find the right cash ISA for you, start comparing the latest deals with Compare the Market.

Which is best – an ISA or savings account?

You no longer need to save into an ISA to earn tax-free interest, so the benefits aren’t as great as they once were. Thanks to the introduction of the personal savings allowance, basic rate taxpayers can now earn up to £1,000 interest a year without having to pay tax on it. For most people that means all their savings will be tax-free. So, when comparing the best cash ISA rates, it’s also worth comparing savings accounts to see if they would offer you a higher return. Where ISAs can be particularly beneficial over time is if you open a Lifetime ISA or stocks and shares ISA.

What do I need to compare ISAs?

At Compare the Market, we currently only compare cash and Lifetime ISAs. You don’t need anything to compare ISA rates, but you will need some basic personal details if you decide to apply, including:

  • your National Insurance number
  • your address
  • your occupation
  • details of any current ISA you want to switch into the new ISA
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Anelda Knoesen

From the Money team

What our expert says

“While ISAs might have lost some of their appeal thanks to the introduction of the personal savings allowance, they still offer a simple way to save tax-free. And they’re flexible as you can start with just £1 and transfer them as many times as you like to get the best rate.”

Why use Compare the Market?

We compare savings accounts, and cash and lifetime ISAs from leading providers Compare savings accounts in under 1 minute** 93.8% of users would recommend Compare the Market to friends or family***

**On average it can take less than 1 minute to complete a savings account comparison through Compare the Market based on data in November 2020.

***For the period 1st September to 30th November 2020, 12,477 people responded to the recommend question. 11,706 responded with a score of 6 or above, therefore 93.8% are likely to recommend.

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