The Individual Savings Account (ISA) was introduced over 20 years ago and since then it’s become an essential part of many financial plans. Since the first ISA, this savings vehicle has evolved and there are four different types of ISA accounts available to open. Which one is right for you will depend on your goals.
What is an ISA?
An ISA is essentially a tax wrapper that allows you to save and invest tax-efficiently. Each tax year, you can place up to £20,000 into ISAs. This annual allowance may be used on a single ISA or spread across several. You won’t be taxed on the interest or returns that are earned within an ISA.
The tax-efficient benefits mean over ten million individuals used ISAs in 2017/18, according to official statistics. Throughout 2017/18, around £69 billion was deposited in ISA accounts. With an initial aim of getting more Brits to save for their future, the ISA has succeeded. However, as the product has become more popular, it’s become more complicated too. There are now four different types of ISA products to choose from.
1. Cash ISA
The Cash ISA is the original ISA product. Cash ISA subscriptions accounted for around seven in ten of all ISA subscriptions in 2017/18. Anyone over the age of 18 can open a Cash ISA.
A Cash ISA is essentially the same as a traditional savings account, except you don’t pay any tax on the interest you earn. The money held in a Cash ISA is protected under the Financial Services Compensation Scheme. This entitles you to compensation up to £85,000 per bank, building society or credit union should it fail.
Whilst your money is secure, interest rates have been low since the financial crisis. As a result, once inflation is considered, savings are likely losing value in real terms. Regular savings cash ISAs, where you deposit a certain amount each month, or fixed-rate ISAs, where your money is locked away for a fixed amount of time, can help you secure more competitive interest rates.
Who may a Cash ISA be right for? Savers with short-term goals in mind and those building an emergency fund.
2. Stocks and Shares ISA
A Stocks and Shares ISA is an investment account, where all capital gains and income are protected from tax. Anyone over the age of 18 can open a Stocks and Shares ISA.
Whilst a Stocks and Shares ISA can provide an opportunity to outpace inflation, delivering growth, it does come with risk. As a result, they are usually better suited to individuals that are saving with a long-term goal in mind. This provides an opportunity for short-term market volatility to smooth out. But you do need to consider the risks before you begin investing.
You can invest in a range of qualifying investments, including stock markets company listed shares on one of the recognised stock markets, public debt securities, such as government bonds, and investment trusts that satisfy certain conditions. Whilst all investments involve risk, there are plenty of options for tailoring risk to your investment profile whether you choose a fund or select your own investments.
Who may a Stocks and Shares ISA be right for? Savers with a long-term goal (minimum five years) and an understanding of investment risk.
3. Lifetime ISA
The Lifetime ISA (LISA) launched in 2017 intending to help more people save for their first home and retirement. You must be aged between 18 and 40, although you can add to an account until you’re 50, to open a LISA.
Additionally, you can add a maximum of £4,000 per tax year to a LISA account. This is because as well as interest and returns, the government will provide an additional 25% bonus on deposits. So, each tax year, you can gain £1,000 in ‘free money’ by maximising contributions. The catch here is that if you make withdrawals before you turn 60, for a purpose other than buying your first home, you will face a penalty. The penalty will mean losing the bonus and some of your own contributions.
For first time buyers, a LISA can offer an attractive way to save a deposit. If you’re saving for retirement, a LISA can top up existing provisions but for most workers, a pension is the best product for retirement goals.
A LISA can either be a Cash ISA or a Stocks and Shares ISA, so it’s important to think about what your goals are.
Who may a LISA be right for? Aspiring homeowners saving a deposit for a first home and those looking to supplement pension savings.
4. Innovative Finance ISA
Innovative Finance ISAs have been available since 2016. They are similar to Stocks and Shares ISAs but are designed to be used for peer-to-peer lending investments. Anyone over the age of 18 can open an Innovative Finance ISA.
Peer-to-peer lending is used by borrowers who did not want to or could not obtain a traditional bank loan. These may be individuals, businesses or property developers. The borrower will offer a rate of interest when paying back the money you’ve invested. Generally, the higher the rate of interest, the higher the investment risk involved.
All investments carry risk, but peer-to-peer lending is typically riskier than traditional investments. The risk involved will depend on the profile of the borrower. Innovative ISA are not covered by the Financial Services Compansation Scheme ‘FSCS’.
Who may an Innovative Finance ISA be right for? Investors with a higher risk profile that are looking to diversify existing investments.
Saving for children and grandchildren
As you review your own ISA choices, now may be a good time to look at how you’re saving for children and grandchildren. Junior ISAs benefit from the same tax-efficient advantages as their adult counterparts. This can make them an excellent way to save for a child’s future.
From the 2020/21 tax year, up to £9,000 can be added to a JISA each year. This money can either earn interest in a Cash JISA or be invested through a Stocks and Shares JISA. As with an adult ISA, your goals and time frame are important when deciding which type of account to use. Money added to a JISA is locked away until the child turns 18.
Please get in touch if you’d like to discuss your current ISAs or how a different ISA product could help you achieve aspirations.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
