Everything about ISAs explained: Should you get one?
Summary: ISAs allow people to invest their savings without paying tax on gains. Read more about the different types of ISA accounts such as cash or stocks and shares.
What is an ISA?
Introduced in 1999, an ISA is an individual savings account that allows investors to reap tax-free benefits from saving and investing without having to pay any tax on growth in their investments or savings, making ISAs an attractive product for investors. There are several types of ISAs, that allow individuals to manage their capital in a variety of ways – the most common being a stocks and shares ISA.
What is the ISA allowance
Whilst ISAs have the benefit of being shielded from capital gains, their primary drawback is they have an annual limit, unlike a savings account.
Every year, the UK government gives every adult a tax-free allowance of £20,000, which are reset at the beginning of each financial year, typically during the first week of April.
For example, if you invest £20,000 in the tax year 2022, you cannot deposit any more funds into your ISA until the next tax year, at which point you can deposit another £20,000. If you don’t use your entire ISA allowance, it does not roll over to the next year, which is why it is advantageous to maximise its potential every year.
Types of ISAs
ISAs come in a variety of forms, each having its own advantages and disadvantages. The table below lists some key information regarding the different types.
Type of ISA
For saving (adult)
Stocks and Shares ISA
Low to high
Low to high
For saving (children to teen)
Innovative Finance ISA
Medium to high
For peer-to-peer lending
Help to Buy ISA
For buying a first home
Low to high
For saving for retirement
Cash ISAs are tax-free savings accounts meaning you do not pay tax on any interest earned. This is typically a much safer approach, as the other types are vulnerable to market volatility, whereas a cash ISA only goes up due to interest accrued. However, if inflation creeps higher than interest rates, the real value of cash decreases, so technically it is possible to end up with less money than you put in.
There are three types of cash ISAs, but it is worth remembering. that individuals cannot have more than one type of cash ISA active during a single tax year.
- Instant-access cash ISAs: Individuals can deposit and withdraw freely from the ISA with typically no restrictions – a minority of providers may impose restrictions. This type of account has a variable interest rate, so the rate of return is subject to fluctuation.
- Regular savings cash ISAs: These accounts typically offer greater rates of interest over instant-access cash ISAs but are not as unrestricted. Individuals will be contracted to a monthly deposit plan with a maximum deposit of £1,666 per month. Withdrawals are also restricted so they will be eligible to withdraw after the term is complete. Generally, the longer the term, the more interest will be earned and therefore greater returns are yielded.
- Fixed-rate cash ISAs: This account offers the greatest rates of interest but are often the longest term and will be the most restricted. Unlike the previous types, the rate of interest is fixed so investors can forecast exactly what returns they will gain over a longer period. Of course, this assumes a constant rate of inflation.
Stocks and Shares ISAs
With a stocks and shares ISA, you are not just saving your money, you’re investing it.
This ISA is often used by investors to reap tax-free gains on capital gains. This includes profits on transactions, dividends, and income. As the typical individual does not exceed £20,000 in trading capital per financial year, these accounts are well suited to retail clients. At Saxo, when you open a stocks and shares ISA with us, you can access to over 11,000 ISA-eligible stocks, ETFs, bonds and commodities, from 60 leading exchanges worldwide.
Besides the standard profits accumulated through buying and selling, investors can also benefit from dividends paid by companies. These are a portion of the company’s profits which are paid directly to shareholders as a bonus for holding equity in the company. Depositing into a stocks and shares ISA offers total flexibility as investors can both deposit and withdraw freely without restrictions - Saxo does not charge any fees for deposits or withdrawals.
Financial markets can be volatile, especially during times of crisis, such as the recent pandemic. This acts as a double-edged sword. Successful investors can accumulate a lot of gains which would significantly outperform other ISA types. However, the risk is equally as big as investments can fall and therefore investors could end up making a loss on their investment.
For example, if an investor buys shares in a company at £10.00 and the share price rises to £15.00, they will yield 50% on their initial investment. But, if the share price declines to £5.00, they would make a loss of 50%. Because of the risk involved, this type of ISA has a minimum age requirement of 18 and a minimum investment, which typically starts from £100.
Lifetime ISA (LISA)
Launched in 2017, lifetime ISAs are the most recent addition to the ISA family. They are typically used to help individuals aged between 18 – 39 to help them save for retirement or their first home.
If you open a Lifetime ISA, you can contribute up to £4000 each year until your 50th birthday and receive a 25% bonus on your deposits from the government. If you wish to use these funds towards retirement, you can only begin withdrawing funds at 60 and use them for whatever you like.
The bonus is paid monthly by the government and helps individuals accumulate capital over time allowing them to invest in both cash, or stocks and shares.
It is possible to hold a Lifetime ISA alongside other cash or stocks and shares ISA, but you will be limited to depositing £16,000.
However, if you plan to use the Lifetime ISA to buy your first home, then there are a few limitations:
- The property must be under £450,000.
- You must be a first-time buyer and not own property anywhere in the world
- Live in the house you’re buying
Note, if you wish to purchase anything other than your first home under the age of 60, you will be penalised with a 25% deduction.
Help to Buy ISA
Ideal for first-time homebuyers, a help to buy ISA is very similar to a lifetime ISA, however, you can only use the funds to purchase a home. This type of ISA has been closed since November 2019 for new customers but still runs for existing account holders. They will continue until November 2030, at which point you cannot claim the 25% bonus granted by the government.
Individuals may deposit a maximum of £3,400 in the first year and £2,400 for any year to follow
To purchase a first home, the property must be under £250,000 outside of London or up to £450,000 in London. At the time of purchase, the government will contribute a 25% bonus. For example, if you have £50,000 in a Help to Buy ISA and wish to contribute it all towards your first home, the government will contribute an additional £12,500. Note that married couples with individual help to buy ISA schemes are both eligible for the 25% bonus.
Unlike the other ISAs, junior ISAs are aimed at younger people under 18. The yearly limit is capped at £9,000, however, this is deducted from the child’s allowance rather than the parents. Therefore, a parent still has their full £20,000 allowance separate from their child. Whilst it is commonly used between parents and their children, the junior ISA can be for any young person, such as a nephew or grandchild. Like a lifetime ISA, the junior ISA can be set up as either cash, stocks and shares, or a combination of both. The payee can deposit funds into the account each year until the child turns 18.
A key aspect of junior ISAs is their management. The young holder cannot withdraw their money until they become 18, at which point they are legally an adult. The account transitions over to becoming a normal ISA and their yearly limit is increased to £20,000. Prior to this, they cannot withdraw their funds. However, at the age of 16, they can legally manage their funds and invest in stocks and shares of their choice.
Note that at ages 16 and 17, individuals are eligible for both an adult and junior ISA so can maintain both accounts. Once they turn 18, they will no longer be eligible for a junior ISA and will only be allowed an adult ISA.
Who can open an ISA?
To open an ISA, you must be a UK resident for tax purposes. You can only open an ISA for yourself and not with, or on behalf, of someone else - except in the case of a Junior ISA.
Specific ISAs have different restrictions in terms of how old you need to be to open one. You must be:
- 16 or older to open cash ISA
- 18 or older to open a stocks and shares ISA or an Innovative Finance ISA
- between 18 and 39 years old to open a Lifetime ISA
- between 16 and 18 years old to open a Junior ISA for yourself
- 18 or older to open a Junior ISA for a child, assuming you’re the child’s parent or legal guardian.
ISAs vs Savings Accounts
Whilst investing in an ISA may provide better returns over a traditional savings account, it is also vulnerable to greater volatility and risk. Risk-averse investors may favour a traditional savings account due to the reliability and safer returns, however, risk-tolerant investors would sway towards an ISA – especially a stocks and shares ISA. Here are several advantages and disadvantages to each:
- Capital limits: ISAs are capped at a maximum deposit of £20,000 per tax year whilst savings accounts are unrestricted. However, the rate of interest offers will be categorised into capital bands – the more money invested in a savings account, the lower the rate of interest.
- Taxable gains: On a traditional savings account, any interest gained is taxable under capital gains tax (CGT). For individual investors in the UK, the personal savings allowance is £1,000 for basic rate residents, £500 for higher rate and £0 for additional. Gains made on an ISA are exempt from capital gains tax. Also, losses can offset profits and could reduce your overall tax bill.
- Flexibility: Individuals who invest into an ISA have a wide variety of products available to them including cash, stocks, REITs and ETFs. This gives the investor much more freedom and choice over how their funds are managed and allocated. On the other hand, a savings account is managed by the financial institution and therefore investors have no say over how their funds are invested.
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