What is an ISA? ISAs explained

Planning to save money for your future? Have you been told to open an ISA? Not entirely sure what that is? Well, you’re in the right place.

Here, we explain everything you need to know about ISAs, from what they are and how they work, to the main features and frequently asked questions.

Ready? Let’s get straight to it!

What actually is an ISA?

ISA stands for “Individual Savings Account”, and it allows you to save and invest money in the UK without having to pay tax on any of the money you make.

By saving money in a savings account, you’ll be paid interest for keeping your money there. And when investing your money, your money grows over time as the value of your investments grow. We’ll dive deeper into what these actually mean later, but with an ISA you don’t have to pay tax on the interest you get, or on the growth of your investments at all. It’s quite a big deal!

So, what’s the story with ISAs? Well, they’ve been around for a while. The Government first introduced them back in 1999 to encourage people to save for the future. Two decades on, and you’ve now got 4 types of ISA to choose from for yourself: Cash ISAs, Stocks & Shares ISAs, Lifetime ISAs, Innovative Finance ISAs, and an extra 1 if you’ve got kids – Junior ISAs. 

Let’s dig into each type of ISA in a little more detail…

Types of ISAs

Cash ISA

This is the most basic type of ISA. You simply put your cash into your ISA and it earns interest, tax-free. Easy-peasy. 

You get Cash ISAs as either a fixed rate (meaning the interest rate stays the same for a certain length of time) or a variable rate (which can go up or down).

A fixed-rate Cash ISA gives you a higher interest rate than a variable rate, but you’ll have to lock your money away for between 1 and 5 years, that means you’ll be putting it in your ISA account and can’t touch it for a while — and the longer you lock your money away, the higher the interest rate you can normally get.

Stocks & Shares ISA

Also known as an ‘Investment ISA’, a Stocks & Shares ISA lets you invest your money instead of saving it. You can invest in various stocks & shares, bonds, or funds to help your savings grow faster.

Stocks and what now?

• Stocks and shares: This is where you buy an ownership stake in a business (meaning you will own part of the company), called a share. Shares are traded all over the world on stock exchanges, and their value will depend on the total value of the company (normally the company value depends on how well they are doing as a business).

• Bonds: Buying bonds lets you effectively loan your money to a company or government and receive interest payments on the amount loaned (similar to a loan you get from a bank). The bond will also have a date they mature, which is when the loan amount will be repaid, with interest.
  
  
• Exchange-traded funds (ETFs): these are shares of many companies grouped together to create a fund. Your money will buy a share of the fund instead of each individual company. For instance, a fund could consist of the top 100 companies in the UK. They are traded on stock exchanges, just like shares.

When you invest in a Stocks & Shares ISA, your ISA provider (the company that looks after your ISA), will work with an investment fund to manage and invest your money sensibly and safely.

The investment fund will split your money between stocks & shares, bonds, and exchange-traded funds (ETFs) to grow your money over time. And over time, your savings will grow, and that money is, you guessed it, entirely tax-free!

As a long-term saving strategy, a Stocks & Shares ISA is a no-brainer. They almost always outperform Cash ISAs (which currently have low interest rates). Here’s a more in-depth comparison of Cash ISAs vs Stock and Shares ISAs.

Lifetime ISA

If you’re a young gun, over 18 and under 40 (hey, 40’s the new 30), and you’re eyeing up a first-time property purchase, a Lifetime ISA could be just what you need.

You can save up to £4,000 a year, tax-free, and the Government adds a 25% bonus to anything you pay in until you turn 50. That means if you manage to save the full whack of £4,000 per year, the Government will give you an extra £1,000 per year, for free. Jackpot!

Of course, the Government isn’t handing out cash willy-nilly. There are rules! A Lifetime ISA is designed to help you buy your first home or save for your retirement, so you can only withdraw the money for those reasons (without paying a hefty charge of 25% to withdraw otherwise).

Lifetime ISAs can be either a Stocks and Shares Lifetime ISA, or a Cash Lifetime ISA. Both act just the same as a regular Stocks and Shares ISA or Cash ISA, but you get the 25% Government bonus too!

If you’ve already bought your first home, or you’ll need the money before you turn 60, there’s no real benefit to opening a Lifetime ISA. You’d be better off saving your money in another type of ISA – our recommendation is a Stocks and Shares ISA.

Innovative Finance ISA

Instead of saving cash or investing in stocks & shares, an Innovative Finance ISA lets you lend your money to borrowers (individuals or businesses) – called peer-to-peer (P2P) lending. 

Peer-to-peer lending is an alternative to borrowing money from a bank, and it’s often used by people looking to grow their businesses.

Over time, the borrowers pay the money back, plus fees and interest. And, like the other ISAs we’ve covered, the interest you earn is completely free from tax!

Junior ISA

The 4 ISAs listed above are for your own savings. But if you want to open an ISA for your children, younger than 16, you can! A Junior ISA (JISA) lets you, as a parent or guardian, save for your nipper’s future. A JISA locks the cash away until your kid’s 18th birthday, after which it’s their money. Whether you tell them about it or not is up to you! Fast car anyone?

You can choose to save into a Junior Cash ISA or a Junior Stocks & Shares ISA (or split the money between the two).

How much can you pay into an ISA?

Once you’ve opened your ISA, you simply pay money into it throughout the tax year (which runs from 6 April to 5 April the following year). You can make one-off payments or set up weekly or monthly payments to automatically transfer the money into your ISA. 

However, if your pockets are overflowing with cash, you should know there’s only so much you can put into your ISA (or ISAs) each tax year. 

This is called your annual ISA allowance. 

• For the 2022/23 tax year, your ISA allowance is £20,000 in total.

• You can split your annual allowance between different types of ISAs. For example, you could save £10,000 in a Cash ISA and £10,000 in a Stocks & Shares ISA. 

• The limit on a Lifetime ISA is £4,000. And this does count as part of your £20,000 allowance.

• The Junior ISA allowance is £9,000, meaning you can save up to £9,000 for your child tax-free. The Junior ISA allowance doesn’t affect your annual ISA allowance of £20,000.

It’s also important to know that:

• You can’t carry forward your allowance: When it comes to the ISA allowance, it’s a use it or lose it situation. You can’t carry it forward into the next tax year.
  

• You can’t replace your money if you withdraw it once you’ve hit your allowance: if you withdraw money, say for an emergency, and want to add it back into your ISA again later, it will count as you putting in new money and count towards your £20,000 allowance. The only exception is if your ISA is flexible – where you can withdraw money and return it whenever you like.

How many ISAs can you have open at any one time?

You can only open and pay into one of each type of ISA each year.

For instance, you could do this with your whole allowance (although adapt to your own budget):

You just couldn’t pay into 2 different Cash ISAs, or 2 different Stocks and Shares ISAs within the same year.

Are ISAs safe?

Yes, ISAs can be a very safe way to save.

They are covered by something called the Financial Services Compensation Scheme (FSCS). That’s a scheme that guarantees your savings up to £85,000 per ISA provider. So, should anything happen to the company managing your ISA, and they go out of business, your money is still protected and you’ll get it back. If you have more than £85,000, you could spread it across several ISA providers if you wanted to be super safe.

And if you’re worried about Stocks and Shares ISAs – don’t be! You might be unfamiliar or nervous about investing your money, but it’s in safe hands. Experts manage everything for you and they know what they’re doing, your money will grow over time. You may find your money falls initially, but don’t panic, investing is for the medium-to-long term, and it will grow over time.

Can you keep an ISA if you move abroad?

You have to be a UK resident to open an ISA. If you open one in the UK then move abroad, you can’t put any more money in after the tax year that you move. You must also tell your ISA provider as soon as you’re no longer a UK resident.

The only exception is if you’re a Crown employee working overseas (such as a member of the UK armed forces, a civil servant, or a diplomat), or their spouse or civil partner.

But, moving abroad doesn’t mean you need to close your ISA. You can keep it open and enjoy UK tax relief on the money already held in it. 

What happens to your ISA when you die? 

We don’t mean to bring you down, but you know what they say about death and taxes – the only 2 things you can be sure of!

If you die, the value of your ISA can be passed onto your spouse or civil partner — but there are a few rules when it comes to ISA inheritance.

• You and your partner need to have been living together at the time of death.
• You can’t be separated by court order, deed of separation, or in circumstances where the marriage or civil partnership has broken down.

If you have a Stocks & Shares ISA, your ISA provider can be instructed to either:

• Sell the investments and pay the money to your family, or
• Transfer the investments to your spouse or civil partner’s ISA (as long as they have the same ISA provider as you).
  

If you want to learn more, we’ve written an article specifically for what happens to your ISA when you die.

Let’s recap

You’ve got some pretty good savings options with ISA – Cash ISAs, Stocks and Shares ISA, Innovative Finance ISAs, and Lifetime ISAs for yourself. And a Junior ISA for your kids. They can even be an ethical ISA too.

If you’re looking to grow your money (A lot), check out Stocks and Shares ISAs – over the medium-to-long term these are your best option – you’ll be thanking us later!

If you’re looking to save money in the short term, perhaps saving for a new car, or would like to build up an emergency fund, then check out Cash ISAs. You'll only get a low interest rate for now, but it’s better than keeping money under your bed.

If you’re looking to buy your first home soon, check out a Lifetime ISA, these can be either a Stocks and Shares Lifetime ISA or a Cash Lifetime ISA, and you get a free 25% bonus from the Government to help towards saving for a deposit.

And best of all, everything you make within an ISA is completely tax-free! Why not start saving today?

Find the best place to save with our best investment platforms UK and our guide to investing for beginners UK.