An individual savings account, or ISA for short, is a way of saving money in a tax-efficient way.
It's a fact that most of us in the UK, and particularly the younger generation, are not saving enough. Recent economic pressures have led many people to see saving as a luxury, but whatever our circumstances we should all get into the habit of saving some of our income, and an ISA is one way to do this.
How do ISAs work?
ISAs are not investments in themselves - instead, they act as tax 'shelters', protecting your cash or investments from tax. There are two basic types of ISA:
- Cash ISA - With a cash ISA, money is placed on deposit and all interest is paid gross without any tax having been deducted. Money can be paid into a cash ISA as a lump sum or in regular amounts.
- Stocks and shares ISA - Permits investments in shares, unit trusts, investment trusts, open-ended investment companies, life insurance policies, corporate bonds and gilts. Money can be paid into a stocks and shares ISA as a lump sum or in regular amounts.
Within the terms of the 2016-17 ISA allowance, you can put some of the £20,000 allowance into a cash ISA and the remaining balance into a stocks and shares ISA. Or, you can put the entire amount into either just one type of ISA. If, at a later date, you decide that you want to transfer your cash ISA into a stocks and shares ISA or vice versa, this is permitted.
- The savings limit for Junior ISAs is £4,128
Frequently asked questions about ISAs
Which type of ISA is right for me?
This will depend on your saving objectives and your attitude to risk. With cash ISAs, you have the security of knowing that your deposited capital is protected, but the caveat is that you may find your potential for earning interest is limited - particularly if you need instant access to your money. If you're prepared to tie up some money in a cash ISA for a fixed period of time, you may be able to glean slightly more interest. With stocks and shares ISAs you need to be comfortable with investment risk, as your underlying capital is not guaranteed and there's always the chance that it may go down in value. This risk may be balanced out if you are investing for the long term, as stocks and shares ISAs will generally outperform their cash counterparts.
How many ISAs can I have?
There are limits on the number of ISAs you can subscribe to each tax year. Current ISA rules allow each individual to have one cash ISA and one stocks and shares ISA per tax year.
How much can I save in an ISA?
With an ISA you have the option to either save on a regular basis or invest an initial lump sum up to the maximum ISA allowance, which is set every year by HMRC.
Saving is a habit, so commit to saving a minimum amount that you can afford every month. Most providers will allow you to start saving from as little as £1 (although some will pay better rates of interest for higher contributions). For stocks and shares ISAs you can invest your full ISA allowance per year, and many providers allow you to invest from £25 per month minimum.
How can inflation affect ISAs?
It's important to bear in mind that if the rate of inflation is running higher than the interest you are receiving within your cash ISA then your money will depreciate in real terms.
What are the tax benefits of an ISA?
You can now earn tax-free interest on cash held in a NISA. (Previously, with the exception of a Cash ISA, any cash held within the stocks and shares element of an ISA was subject to a 20% charge on the interest earned - paid to the HMRC.)
What if I need to get my money out of an ISA quickly?
It depends on the terms and conditions of the ISA you have taken out. With most cash ISAs you can withdraw money without losing any tax benefits already built up. However, with some accounts, you may lose interest if you withdraw money early. Some cash ISA plans are designed for the money to be held for a set period. With investment ISAs there may be withdrawal charges, so always check the terms and conditions before committing to anything.
Can I transfer an ISA?
Many ISA providers will accept ISA transfers from other providers, although you should check to make sure that you understand the timescales involved for transfer. Some providers can be a bit slow in instigating the transfers. This means that if you're not happy with how your ISA is performing you have the option of voting with your feet. You can move your money if your existing ISA provider becomes uncompetitive and you find that you can get a better rate of interest elsewhere. This is especially true for cash ISAs. For stocks and shares ISAs the same principle applies, although with these types of investments you should take the long view on performance and not necessarily move your ISA on the basis of a less-than-stellar short-term investment performance. For more information, see ISA transfers.
What charges might I be expected to pay on an ISA?
This will depend on the individual ISA provider, so check with them for any charges applied for withdrawals or transfers, or if you need to access your money early.
Can I take out an ISA for my child?
In November 2011 the UK government launched Junior ISAs for children born after 2nd Jan 2011 or before 1st September 2002. For children born between these dates, junior ISAS are not available, as they will have received between £50 and £500 from the government to be invested into Child Trust Funds. With a junior ISA, a parent can invest up to £4,128 per tax year on behalf of each child. The money can only be accessed once the beneficiary turns 18, so it's a practical way to save for your child's future.
When were ISAs introduced and how have they been received?
Individual Savings Accounts (ISAs) were introduced in the UK in 1999, replacing Personal Equity Plans (PEPs) and Tax-Exempt Special Savings Schemes (TESSAs) as a simplified savings model for people aged 16 and over. The current ISA market is estimated to be worth over £400 billion. According to TISA (the Tax Incentivised Savings Association), ISAs are now established as a core savings product for 42% of UK households.
In the tax year 2010/11, figures from the Office of National Statistics showed that people in the UK put more money into ISAs than they put into pensions. Approximately £15.8 billion was placed in stocks and shares ISAs and around £38 billion went into cash ISAs. Meanwhile, pension contributions in the same tax year amounted to approximately £14.2 billion.