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ISAs explained

Looking for a better way to save? ISAs are a sensible option…

An ISA is easy to understand, flexible, and best of all, you don’t have to pay UK tax on your savings or investments.

In this guide, we’ll take you through the different types of ISA, how they work and what the benefits and risks are.

We’ll also help you understand investing with an ISA, so you know how to get started if that’s what you choose.

This ISA guide will help you to...

  • Understand the basics of ISAs and how they work
  • Compare the different types available
  • See how much you can put into ISAs each year (the ISA allowance) and other ISA rules

Explore your simple guide to ISAs

What is an ISA?: the basics

The basics of ISAs are easy to understand.

what is an ISA?

An ISA is an Individual Savings Account. There are different types of ISA to help you save or invest, depending on your goals. The four main types are Cash ISAs, Stocks and Shares ISAs, Lifetime ISAs, and Innovative Finance ISAs.

If you’re a UK resident over 16, you can have a Cash ISA. From age 18 you can also have a Stocks and Shares ISA, Lifetime ISA (if opened under 40) and Innovative Finance ISA.

It’s also possible for a parent or legal guardian to open an ISA for a child under 18. If they’re 16 or over, the child can open one themselves. You can find more information about Junior ISAs here

The two main benefits of ISAs is that they’re free from UK tax and you can withdraw money whenever you need to. But if you choose to invest in an ISA, it’s best to take a long-term view.

ISA Allowance

Each tax year (6 April to 5 April), there’s a maximum amount of money you can put in ISAs, called the ISA allowance.

You have until 23:59 on 5 April each year to add money to your ISAs, and the allowance each year doesn’t carry over.

In the 2021/2022 tax year the allowance is £20,000.

ISA Allowance

The ISA allowance is only for the money that you put into ISAs each year. It doesn’t include the total amount that’s in your ISAs from previous tax years, or the money you earn from investments in your ISA.

So if you put £10,000 in an ISA in the 2019/20 tax year, you could still put up to £20,000 in this tax year. You can only put a maximum of £4,000 into a Lifetime ISA each year.

If you put £20,000 in a Stocks and Shares ISA and your investments grow, that growth won’t count towards your allowance, but is still free from UK tax. This way, over time you could potentially hold quite a substantial pot tax-free in an ISA.

How many ISAs can I have?

You can have any number of ISAs. But you can only pay into one of each type each tax year. You just need to make sure the money you put in across all your ISAs each year doesn’t go over the total ISA allowance.

Types of ISAs

ISAs allow you to shelter your money from the taxman and there are a number of ways you can do this.

types of ISAs

Cash ISAs

A Cash ISA works just like a normal savings account, except you don’t pay income tax on the interest you earn. It’s a stable way to save, since your money won’t be invested in the stock market.

There are two main types of Cash ISAs – variable and fixed rate. Fixed rate Cash ISAs usually offer slightly higher rates than variable Cash ISAs, but the idea is that you don’t withdraw your cash before the fixed term – sometimes you still can, but you might be penalised. Variable rate Cash ISAs, typically called easy or instant access, will allow you to withdraw your money whenever you like, but will pay a lower rate in return.

When keeping your money as cash you need to take inflation into account. If the rate of inflation is higher than the interest rate you’re earning, your savings could actually go down in value over time in real terms.

Our inflation calculator gives you an idea of how inflation can affect the value of your savings, and how much interest you’d need to keep pace.

It’s always a good idea to keep some money as cash, for things like an emergency fund, or for expenses you know are coming up. But once that’s done, a Cash ISA might not always be the best way to save for the long term. If you can accept the risk that your money will go down as well as up in value, a Stocks and Shares ISA could be a better option.

Cash ISAs at a glance

  • Low risk way to save money
  • No UK income tax
  • Fixed and variable rates available
  • Inflation could reduce your savings’ worth over time

Tax rules can change and benefits depend on individual circumstances.

Discover the HL Cash ISA

Stocks and Shares ISAs

With a Stocks and Shares ISA you can put money into an ISA and use it to buy shares, funds and other types of investments.

The money you invest is free from UK capital gains and income tax. By investing you can potentially grow your money more than just saving in a Cash ISA. But there is risk with investing, because investments can go down in value as well as up, meaning you could lose money.

Stocks and Shares ISAs are generally best for investing for at least five years. That’s because the longer you invest, the greater the chance that your money will outperform cash.

When your money’s invested in a Stocks and Shares ISA you can still withdraw it whenever you need to – but remember investing should be for the long term. Your investments will need to be sold first though, so your money might not be available for a few days.

Find out more about Stocks and Shares ISAs including charges

Stocks and Shares ISAs at a glance

  • No UK income or capital gains tax
  • Freedom to invest if you’re comfortable with the risk (you can also hold cash)
  • Withdraw money when you need to
  • Potential to grow money over the long term
  • Risk of losing money, because you’re investing in the stock market
  • Withdrawing money may not be immediate – it can take a few days

Tax rules can change and benefits depend on individual circumstances.

Open a Stocks and Shares ISA

Lifetime ISAs

Lifetime ISAs were created to give you a boost towards buying your first property. If you’re aged between 18 and 39 years old, you can put in up to £4,000 into a Lifetime ISA and the government will add an extra 25%, up to £1,000 a year. All money in your Lifetime ISA is free from UK tax, so it’s a great boost to your savings.

Use our Lifetime ISA calculator to see how much of a boost you could get

There are strict rules about when you can take money out of a Lifetime ISA without paying a government withdrawal charge. You can withdraw your money if you’re buying your first home (with a purchase price of up to £450,000). You also have the option of leaving the money in your Lifetime ISA and withdrawing it from age 60.

Find out more about Lifetime ISAs including charges

In most other cases, if you want to withdraw your money you will pay the government withdrawal charge of 25% of the amount withdrawn, so you could get back less than you put in.

Lifetime ISAs at a glance

  • Save for your first home (or retirement)
  • Get up to £1,000 a year, free, from the government
  • Save cash or if comfortable with the risk, invest in the stock market
  • Only eligible to open an account if you’re 18-39 years old (though you can continue to contribute up to your 50th birthday if you already have an account)
  • Strict rules on what you can withdraw the money for, and when, without paying a government withdrawal charge

Tax rules can change and benefits depend on individual circumstances.

Open a Lifetime ISA

Help to Buy ISAs

Before Lifetime ISAs were introduced in April 2017, Help to Buy ISAs offered a way for people to save towards their first home. But they do have some differences to the Lifetime ISA.

Help to Buy ISAs have a smaller government bonus (up to £3,000 total), a lower ISA allowance (£2,400 per year) and a lower maximum house price (£250,000 or £450,000 in London).

Unlike with a Lifetime ISA, you can’t invest your Help to Buy ISA for potentially better returns. With the increased options for Lifetime ISAs, you’re now allowed to transfer a Help to Buy ISA to a Lifetime ISA. But please note, the transfer will count towards your yearly Lifetime ISA allowance.

Find out more about transferring

Innovative Finance ISAs

An Innovative Finance ISA (IFISA) is for peer-to-peer lending and investments.

It lets you use the yearly ISA allowance to lend funds directly to other investors via the Peer-to-Peer lending market. Like all other ISAs, your money is free from UK income and capital gains tax.

While interest rates tend to be generous in IFISAs, as with any form of investing, your capital is at risk and you could lose money.

To find out more about Innovative Finance ISAs and Peer-to-Peer lending, please visit www.innovativefinanceisa.org.uk

Cash or the stock market?

Cash ISAs are one way of saving for the future, and the interest they generate can provide additional income too. However, the interest rates banks offer don’t always keep up with inflation.

What is an investment

How inflation erodes your buying power

Average inflation
What £1,000 will be worth in real terms
After... 2.5% 5.0% 7.5% 10.0%
5 years £884 £784 £697 £621
20 years £610 £377 £235 £149
40 years £372 £142 £55 £22

If inflation is higher than the interest rate on your cash savings, prices are increasing faster than your money is growing. This means that the real value of your savings falls over time. With this in mind, it’s no surprise people are looking for alternatives.

An alternative to keeping money in a cash account is to invest. Over time, stock markets have consistently delivered better returns than cash accounts.

Past performance is not a guide to future returns, and stock market investments can go down in value as well as up. If you invest in the stock market you could get back less than you put in.

The tax benefits of ISAs

All ISAs allow you to save and invest without paying UK income or capital gains tax.

What is an investment

While most savers also won’t pay tax on interest in regular bank or building society savings accounts, if you have a sizeable savings pot, ISAs could potentially save you quite a lot in tax.

Rates of tax Basic rate tax payer Higher rate tax payer Additional rate tax payer ISA investor
Capital gains on most investments (in excess of the £12,300 annual allowance) 10% 20% 20% 0%
Dividend income over £2,000* (i.e. income from shares) 7.5% 32.5% 38.1% 0%
Interest income (i.e. from cash, corporate bonds and other fixed interest investments)* 20% (over £1,000) 40% (over £500) 45% 0%

Tax rules can change and benefits depend on individual circumstances.

*This example assumes an individual has fully used their personal allowance and none of the interest falls within the starting rate for savings.

Transferring ISAs

You can move your ISAs to a new provider as often as you like, and whenever you want.

The best part is, transferring doesn’t count towards your ISA allowance (although if transferring to a Lifetime ISA it may count towards your Lifetime ISA allowance).

What is an investment

Transferring between types of ISA

You can also move between types of ISA, for example if you’d like to transfer your Cash ISA to a Stocks and Shares ISA. Just remember that if you have a fixed rate Cash ISA and you transfer it before the fixed term ends, you may have to pay a penalty.

Transferring part of an ISA

There’s one catch with transferring – if you’re transferring an ISA you paid into this year, you have to transfer the whole amount from this year. For example, let’s say you want to transfer from a Cash ISA to a Stocks and Shares ISA. You have a Cash ISA with £40,000 in it from previous years, and this year you’ve added £10,000 to it. You can transfer all or just part of the £40,000 from previous years to your new Stocks and Shares ISA. But you’d have to transfer the entire £10,000 you’d paid in this year if you wanted to move it.