Should I get an ISA?

Is it worth having an ISA?

Yes, it can definitely be worth having an ISA as they come with significant tax advantages and sometimes, even government bonuses. When you save in a traditional savings account, like one you might hold with your high street bank, you may have to pay tax on the interest you earn if you go over your personal savings allowance (PSA). But with an individual savings account (ISA), you can save up to £20,000 a year without paying any tax on your savings interest.

The money you hold within your ISA also won’t count towards your personal savings allowance, so you can still put some of your cash in a standard savings account or current account while staying within your PSA limit.

You can stick to just one ISA if you wish, or you can spread your annual ISA allowance across multiple ISAs.

A couple of years ago, very few people paid tax on their savings interest, due to low interest rates and the personal savings allowance (PSA), which protects the first £500-£1,000 of interest you earn each year. But interest rates have risen significantly since the pandemic, with the Bank of England increasing its base rate from 0.10% in December 202 to 5.25% today.

Interest rate rises make saving more rewarding, but they also increase the likelihood that your savings interest will be taxed. So if you’re saving for an emergency, car or house deposit in a traditional bank account, your savings might not grow as quickly as they could in an ISA.

Even if you’re not saving enough to pay tax on your interest now, another advantage of opening an ISA now is it could offer you protection in future. If interest rates rise, your income increases or you receive a financial windfall like inheritance, you could eventually exceed your PSA and become liable for tax — unless your money is tucked away nicely in an ISA wrapper. ISAs have additional advantages for those who are married or in a civil partnership too. If one partner passes away, the surviving partner can inherit their loved one’s ISA allowance. 

Let’s imagine a widow inherits their late spouse’s £50,000 Cash ISA savings, which the deceased had built up over a number of years. The surviving spouse’s ISA allowance would then increase by £50,000, to ensure that the savings could be transferred tax-free.

What ISA should I get?

The right ISA for you will depend on a number of factors such as your goals and attitude to risk. A Lifetime ISA (LISA) lets you save up to £4,000 a year towards your first home or retirement and benefit from a 25% bonus from the government. You can choose from a Cash Lifetime ISA, where you’ll earn interest growth on top of your savings, or a Stocks & Shares Lifetime ISA where your money will be invested in the stock market. 

If you’re saving for short-term goals such as a holiday, wedding or new sofa, a Cash ISA is likely to be your best bet as you can use the funds for whatever you like. Plus, depending on what account you choose, you can usually withdraw the funds easily and whenever you want. Another option is a Stocks and Shares ISA, which lets you invest your savings into the stock market, but it can take longer to see a return on your savings.

Read more: Lifetime ISA vs Cash ISA

You might also like: How to start investing

What are the types of Cash ISAs?

There are lots of different Cash ISAs to choose from including easy access accounts that let you withdraw your money at any time, without any penalties and notice Cash ISAs that require you to give notice before you withdraw funds. You can also get fixed-rate Cash ISAs, where you’ll earn a fixed interest rate for a set period of time. But if you access your savings before the end of the fixed term, you’ll need to pay a penalty. You can also get a Cash Lifetime ISA, which allows you to get up to £1,000 free from the government towards your first home or retirement each year you save into the account.

If you withdraw money from your LISA for something other than an eligible property or retirement, you’ll be charged a 25% fee on the amount you withdraw. Here’s more info about how to avoid the LISA withdrawal penalty. 

Learn more: Best Cash ISAs in the UK

What are the types of Stocks and Shares ISAs?

A Stocks and Shares ISA lets you invest up to £20,000 a year without paying capital gains tax (CGT), taxes on bond interest, or tax on your dividend income. Some Stocks and Shares ISAs let you choose your own investments. This is generally known as ‘active’ investing. Others encourage a more passive approach, letting you choose from a small selection of funds created and managed by a fund manager. 

The right Stocks and Shares ISA for you will depend on your experience, knowledge and goals. If you’re a new investor, choosing your own investments can be riskier than using a fund manager. It can be more time-consuming too, as it generally requires more research and a stronger understanding of how the stock market works. 

If you choose a Stocks and Shares ISA with an app, you may be asked a series of questions during the sign-up process to establish your goals and attitude to risk. This can be really valuable, particularly if your answers influence the investments that are recommended to you.

Like most types of investment accounts, Stocks and Shares ISAs often come with fees such as platform charges, management fees, trading fees and ‘transfer out’ fees. So it’s important to compare a few different ISA providers before opening one. 

If you’d like to invest but you’ve got no idea where to start, take a look at our How to start investing guide.

What is an Innovative Finance ISA?

An Innovative Finance ISA is a type of ISA investment account, but your money will be used for peer-to-peer lending. This means your money will be lent to businesses and borrowers and you’ll get interest in return. Your interest won’t be taxed, but your ISA provider will take a percentage of your interest. This means that the interest you earn will be slightly lower than the interest rate paid by the business or borrower. 

Keep in mind that if the borrower is unable to repay the loan, you may lose money. You can mitigate the risk by spreading your cash across multiple loans, but even with diversification, there’s no guarantee that you’ll get back what you put in.

Learn more: How much should I have in savings?

Is it better to save in an ISA or savings account?

It depends on how much money you want to save and how long you plan to save for. If you’re saving for a large expense, you’re saving over a number of years, or you’re a high earner without a personal savings allowance, you’ll usually be better off with an ISA. For small, short-term purchases, you could use a traditional savings account or an easy-access Cash ISA. 

Learn more: How many Cash ISAs can I have?

Should I get a Lifetime ISA?

If you’re a first-time buyer and you’re saving for a home, or you’re saving for your retirement, a Lifetime ISA can often be a no-brainer. Your savings will be boosted by a 25% government bonus up to £1,000 each year you pay into the account, your interest will be tax-free, and if you choose a Cash LISA with a competitive interest rate, you’ll also earn interest growth on your savings! 

If you can save more than £4,000 a year, you can have a Cash ISA and a Lifetime ISA. Simply max out your LISA to make the most of the bonus and place any additional savings in a Cash ISA.

Should I pay into a pension or ISA?

It depends on your employment status, income and goals. You might be better suited to one or the other but in some cases, you can benefit from paying into both. If you’re employed and you’re a basic-rate taxpayer, your pension will usually be more rewarding than an ISA and even a Lifetime ISA. That’s because not only will your contributions benefit from tax relief, but your employer will contribute too. 

It’s usually a good idea to pay as much as you can into your pension to make the most of your employer contributions. If for example, your boss will match your contributions up to 5%, it’s wise to pay at least 5% of your salary into your pension. If you can afford to save more than this for retirement, you could contribute a larger percentage to your pension or add anything extra to an ISA or Lifetime ISA. Remember that by not contributing to a pension scheme, you may lose the benefit of contributions by an employer (if any) to that scheme. Saving in a LISA may also affect your entitlement to means-tested benefits.

If you’re self-employed and a basic-rate taxpayer, you could save in a Lifetime ISA, private pension or both. A private pension won’t be quite as rewarding as a workplace pension, since you’ll miss out on employer contributions. But with the help of tax relief, an £80 pension contribution will be worth £100, as the money will be taken from your pre-tax income. If you were to use a Lifetime ISA instead, you’d be no worse off. That’s because an £80 LISA contribution from your post-tax income will be boosted to £100 thanks to the government bonus. 

There are, however, significant differences between a LISA and a pension when it comes to drawing your funds in later life. To work out which option is best for you and your goals in the long term, speak to a financial adviser.