What are the different types of ISA available?

12 March 2020

When it comes to saving into an ISA, there's never been so much choice. But how do you pick the right type of ISA? Our simple guide explains how ISAs work, how to choose them and what they have to offer:



What is an ISA?

If you want your savings or investments to grow at the best possible rate then an ISA – an individual savings account - can help. These are savings and investment vehicles where your money can grow largely free from tax.

And an ISA should always be thought of as a tax-efficient way of saving. Even better, you escape capital gains tax when you come to cash in your investment. You don’t even have to include savings held in an ISA on your tax return.

Money invested wisely in ISAs will grow faster than in the best standard savings account because no tax is deducted.

Even when interest rates are low it's worth putting your money into an ISA, so that when rates do eventually rise that money can grow tax-efficiently.

How to choose an ISA

Invest in an ISA at the beginning of the tax year and your money is then working for the whole 12 months. Many people leave it until the end of the tax year and miss out on a full year of potential growth.

If you want to have some of your ISA savings in cash, you'll also need to make sure the account terms are right for you as well as picking a best buy rate of interest. The fixed-term accounts pay the highest rates, but have restrictions on withdrawals.

Savers can shelter a mixture of cash and stocks and shares up to £20,000 in their ISA, which does not need to be declared on any tax return. This money is also safe from capital gains tax on profits you make from share price increases.

And remember: you are only permitted to put money into one cash ISA, and/or one stocks and shares ISA, and/or one lifetime ISA, and/or one innovative finance ISA during the course of a tax year.

This kind of investing needs to be viewed as a medium to long-term investment – at least five years – in order to ride out the ups and downs of the market.

Basic ISA

This is the most popular type of ISA and is used to shelter cash savings, as well as stock-market investments from both income and capital gains tax.

You have to be at least 16 years old to open one (18 in the case of shares or investment funds) and for the 2019/2020 tax year, up to £20,000 can be put into a basic ISA.

In the past, there have been stricter limits on how much of the basic ISA can be used for cash savings, but now the full amount can be used for cash.

Interest on cash ISA accounts is free of income tax, while any gains made on stock-market investments are free of capital gains tax.

Given the tax advantages, a basic ISA should be most people’s first choice when it comes to putting money aside.

Junior ISA

Aimed at parents who want to save on their children’s behalf, the Junior ISA also allows money to be put into cash or shares and investment funds.

The annual limits are, however, lower than on the basic ISA. As announced in the March 2020 Budget, £9000 can now be put into a Junior ISA from the next tax year. Again, savings interest and investment gains are not taxed.

Control of the money in a Junior ISA passes to the nominated child when they turn 16, but no withdrawals can be made until their 18th birthday. At this point, the ISA converts to a basic adult ISA.

Stocks and shares ISAs

Savers often think of cash as a safe haven. But inflation can be prone to eroding its value and giving a negative return.

Those with a longer time scale for getting their money to work hard, before they need it, should look to build an investment portfolio.

Savers need a balanced portfolio that uses a mix of investments across different sectors, regions and investment styles. You can invest in individual stocks or leave stock picking to the experts and invest in a fund which holds a number of stocks.

Pay attention to fund charges applied to your ISA – and don’t pay over the odds by just going to your bank. Do some research to find out where the best value for money is.

Inheritance ISA

This type of ISA is aimed at people whose partners had an ISA at the time of their death. It is available to anyone who has lost a husband, wife or civil partner since December 3, 2014.

The value of their ISA at the time they died is added to your own ISA allowance, which effectively means you get to inherit their savings or investments without facing any tax charges.

However, it’s important to note that an Inheritance ISA must be opened within three years of the death, although this can sometimes be extended in cases where the estate is still being administered.

Flexible ISA

In the past, withdrawals from basic ISAs have been subject to strict rules: any money taken out of an ISA cannot be re-deposited without eating further into the annual allowance.

But the rules have changed. If money is taken out of a Flexible ISA, it can be put back in the same financial year without you losing any of your tax-free allowance.

This is especially useful for people who might want to access their cash savings from time to time.

Innovative Finance ISA

The growing popularity of alternative savings and investments, such as peer-to-peer loans and crowdfunding services, led to the creation of the Innovative Finance ISA.

This means that returns on such deals will be free of income and capital gains tax. The annual limit is the same as the basic ISA – £20,000 from back in April 2019.

Peer-to-peer lending involves lending money directly to other individuals: returns are better than on bank deposit accounts, but there is a risk you could lose money if borrowers default or miss repayments.

Crowdfunded investments tend to involve taking stakes in small, new companies and can be particularly risky, even when compared with stock-market investing.

Lifetime ISA

The Lifetime ISA is aimed at the under-40s. It allows up to £4,000 a year to be saved, with the government adding a 25% bonus.

The idea is that the Lifetime ISA should be used to help save for a deposit on a property, or for retirement as an alternative to a pension. Anyone aged between 18 and 40 can open one of these ISAs, and bonus payments will continue until the age of 50.

But the bonuses are only paid on the Lifetime ISA if the money is used to buy a first home or if it is withdrawn after the age of 60. Withdrawals for other purposes or before the holder’s 60th birthday will mean the government imposes a 25% penalty, which effectively offsets any bonus payments.

Mix and match ISAs

You might want to split the allowance between cash, stocks and shares and innovative finance ISA with any split you feel comfortable with.

But remember the rules that, combined, your tax-free ISA savings in the tax year must not exceed £20,000, and you can only open and hold one cash ISA over the course of the tax year.

If taking this mix and match approach, it’s sensible to do your homework to see how a variety of banks and building societies set up their ISAs, as these can vary considerably.

For more tips and useful information, browse our money articles.

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The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.