How to choose the right ISA for you
If you’ve ever opened a newspaper’s financial pages, chances are you will have seen an expert recommending ISAs as a good way of managing your money.
Despite the powerful tax benefits of these accounts, government figures show that fewer than half of us (43%) have an ISA. In fact, the number of people opening ISAs has fallen in recent times, perhaps due to the low interest rates on cash savings.1
What is an ISA?
ISA stands for individual savings account. Put simply, it’s a ‘wrapper’ that can shield your savings or investments – be it cash or equities – from being taxed, rather than being an investment in its own right
All types of ISA have an annual limit – an amount you can pay in every year – and as long as you keep your money within the ISA wrapper, it will grow tax free. That makes it possible to build up a very large pot over time.
What can you hold in an ISA?
ISAs enable you to save or invest in a variety of ways. The most commonly held ISAs are cash savings accounts. However, you can also hold investments in an ISA, including individual shares, mutual funds and even bonds.
Recently, a new innovative finance ISA (IFISA) was introduced. Just like a cash or stocks and shares ISA, an IFISA offers you a way to invest without paying tax on interest or capital gains. But instead of using it to save cash or buy shares, an IFISA enables you to invest your money in bonds, loan notes and peer-to-peer (P2P) loans.
How much can you put in an ISA?
ISA allowances vary depending on the type of ISA you’re using. For most, you can put in £20,000 during the 2018/19 tax year. And if you want to use your allowance across different types of ISA, you can split it between them. For example, you could put £10,000 in a stocks and shares ISA, £5,000 in a cash ISA and £5,000 into an IFISA.
Other types of ISA have different limits. Help-to-buy ISAs, which offer a government bonus of 25% to help first-time buyers, enable you to put in £200 a month, up to a maximum of £12,000. Lifetime ISAs, which offer a similar bonus to under-40s saving for a first home or for retirement, have an annual limit of £4,000.
Which ISA is right for me?
Using your ISA allowance for cash savings is now less attractive, because everyone has a personal savings allowance (PSA). This enables basic-rate taxpayers to receive £1000 of interest tax free every year and higher-rate taxpayers to receive £500.
If you’re looking to buy a home, both lifetime and help-to-buy ISAs offer generous bonuses and you can save in cash or shares. The lifetime ISA is more flexible, as it can also be withdrawn after the age of 60 for use in retirement.
Investment ISAs come with more risk because the value of your money could go down as well as up, so it’s important to understand this before opening one. However, historic data shows that stock investments tend to outperform cash over the long term, so may offer better returns in an environment where inflation is outstripping cash savings rates.
If you’re still unsure which type of ISA is right for you, an independent financial adviser (IFA) can help you make sense of the options available and decide which is most suitable for your risk tolerance.