Do you have the wrong ISA?

Individual Savings Accounts, or more commonly known as ISAs, are one of the most tax-efficient methods of saving and investing and are available to UK residents only.

Any interest, dividends, or capital gains earned within an ISA are usually exempt from income tax and capital gains tax, which hugely benefits individuals in boosting returns on investments compared to holding them in taxable accounts. This is why it’s wise to understand the importance of ISAs and understand how they form a useful tax-efficient element of your holistic financial plan. But what are the different types of ISAs available to you, and what are the benefits they can offer you in differing stages of the financial planning life cycle. ISAs are inherently useful, but used at the wrong time in your life can make them inefficient in achieving your financial goals. Of course, managing your assets is a highly personalised process, and how much you want to allocate to ISAs should reflect your own individual circumstances.

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How much can I invest into an ISA?

The ISA allowance for the current tax year 2024/25 is £20,000, which it has remained at since 2017 when the Government announced plans to freeze this and other allowances until 2026, which was later extended to 2028. You can allocate your entire allowance to one type of ISA or spread it across the different types that we’ll look at shortly. The good news is the new tax year 2024/25 introduced a new rule, where you can open multiple ISAs of the same type with more than one provider in the same tax year, whilst retaining your annual allowance.

The different types of ISAs

Cash ISAs – These are specifically designed for cash savings accounts offered by banks and building societies. Cash ISAs, much like standard taxable savings accounts, come in various forms, including instant access accounts, regular savings accounts, fixed-rate accounts, and variable-rate accounts. This allows individuals to choose the type of account that best suits their savings goals and preferences.  And of course, all interest earned, whilst held in an ISA, is tax free.

If you are interested in exploring what cash ISAs have to offer, please check out the Savings Champion website, which compares the best accounts on the market.

Stocks & Shares ISA – These offer the opportunity to invest your cash into wide range of investments, from individual stocks to collective investment funds. These are well-suited for long-term investing, as they offer the potential for higher returns compared to cash savings. However, as the returns are linked to the performance of the investments, the value of the investment could fall as well as rise.

Lifetime ISA (LISA) – These are designed to help young people save for their first home or retirement and can either be held as cash or investments. To be eligible, you must be aged between 18 and 40 and can contribute a maximum of £4,000 per tax year. To incentivise savers, the Government contributes an additional 25% bonus on your contributions up to a maximum of £1,000 per tax year.

The cut-off date for contributions into this type of ISA is 50 years old, however, your account can stay open, and your cash savings or investments can continue to grow. If you opt to not use your funds to purchase your first home, the earliest you can access the money is at age 60. 

Junior ISA (JISA) – These offer a long-term saving and or investment opportunity for children under 18. They can also be in the form of cash or stocks and shares ISAs. The annual allowance is £9,000 per tax year, and the money cannot be accessed until the child turns 18. Parents or guardians can open a Junior ISA, but the child can take control at age 16 and withdraw money at age 18.

Innovative Finance ISA – This ISA contains peer-to-peer loans instead of cash or stocks and shares ISAs. Peer-to-peer lending matches lenders up with borrowers in return for interest. As banks are not used and money is invested through an online portal, you can potentially earn higher interest rates than a traditional savings account. Please be aware that these are slightly more complex ISA wrappers and are not protected by the Financial Services Compensation Scheme, so the risk of losing money is higher.

A new 'British ISA' was announced in the Spring Budget and is still under consultation. What we know at this point however, it should offer an additional £5,000 tax-free ISA allowance for investments into British companies, and should be in addition to the standard £20,000 ISA allowance which has remained unchanged.

Further details to follow including when this will be available.

Which ISA is right for you?

How to select the best ISA for you will be determined by your individual savings goals, attitude to risk and time horizons to grow your pot. The following scenarios attempt to demonstrate which ISAs might be suitable for individuals at different stages in their life cycle.

For a young individual with a keen interest in building a large asset base to supplement pension income for retirement, a stocks and shares ISA could be a good option, and with a long-time horizon, short-term volatility is less likely to be an issue. This approach could see better returns over the long-term when compared to cash returns over the same time horizon. 

However, those with their eye on retirement in the near future, will most likely want to take a lower risk approach than a stocks and shares ISA. Here, a cash ISA might be a more suitable option to minimise exposure to market volatility and any short-term losses. 

Having multiple ISAs working in cohesion with one another may be an optimal solution for a number of individuals. A young family for example, might want to set up a junior ISA for their children to help save for their future. Alongside this, they may want to subscribe to a lifetime ISA if they are looking to purchase their first property. Care should be taken when assessing the suitability of a lifetime ISA;. although the 25% government bonus is appealing, if you decided to not use the funds for your first house purchase, there is restrictive access until age 60, as well as limits on the value of the property that the ISA can be used for.

Do I have the wrong ISA?

It’s important to ask yourself this question and think to yourself, do I have the right ISA for me? You will need to assess your own personal short- and long-term goals; whether you want to save for the future or set aside some money to use in the short term, in a tax- efficient environment. Some rules can be restrictive and falling foul of the rules could cost you.

Having the wrong type of ISA for your objectives can make them ineffective. Although they appear to be simple wrappers, it is recommended to seek advice from professionals who have the expertise in this area, to help guide you through your overall financial plan.

If you’d like to learn more about how ISA can work within your financial plan, why not get in touch. We’re currently offering those with £100,000 or more savings, investment or pensions a free financial review worth £500.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions. 

Investment returns are not guaranteed, and you may get back less than you originally invested. The Financial Conduct Authority (FCA) does not regulate Savings Champion and their associated services, cash or tax advice.