ISAs: your guide to tax-free savings

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ISAs tax-free savings explained young girl putting money in money box while parents watch

Want to maximise your tax-free savings allowance? With an ISA, you can make your money work harder for you – here’s how to get started and open an account

An ISA allows you to keep your money safe while hopefully benefiting from tax-free interest. Whether you open a cash ISA for yourself, or a stocks and shares ISA for a grandchild, don’t let your annual tax-free savings allowance go to waste…

ISA stands for Individual Savings Account. It is simply a type of savings account, from which you receive tax-free interest, capital growth or dividends. There are six main types of ISA, each of which holds or invests your money in different ways:

• Cash ISA: Your money accrues interest, with no risk of losing capital. Accounts can be ‘easy access’ (free to withdraw or transfer from whenever you wish) or ‘fixed rate’ (penalties may apply if you withdraw before an agreed date).

• Stocks and shares ISA: Your money is invested in shares, funds or bonds, with any returns (i.e. capital growth or dividends) paid to you tax-free. As with all such investments, its value may rise or fall. 

• Junior ISA: The same cash/investment options as above, but for a child aged under 18. Must be opened by a parent or guardian, on behalf of the child.

• Lifetime ISA: Available to investors aged 18-40, LISAs can only be used to buy your first property, or access when you’re 60+. The government contributes a 25% bonus to your LISA, up to £1,000 per year. Available in both cash, and stocks and shares options. 

• Help to Buy ISA: Assisting first-time buyers to get on the property ladder, this account also includes a government top-up: £50 for every £200 you pay in per month. However, these accounts are no longer open to new applicants. 

• Innovative Finance ISA: An IFISA links up investors with businesses looking for investment. They may promise high returns, but are riskier than the above ISA options, and are only offered by peer-to-peer lenders – so your money is not protected by the Financial Services Compensation Scheme. 

How much can I put into an ISA?

ISAs tax free savings explained ISA

In the 2021/22 financial year, you may save up to £20,000 into one or multiple ISAs. You may not exceed a total of £20,000 across all of your ISAs. This figure does not include any returns or interest accrued – only personal contributions.

Your ISA allowance renews every financial year (on 6 April), so you may contribute further funds – with the aim of benefiting from compound interest. 

How many ISAs can I have?

You can only open one type of ISA per year, but you may hold multiple accounts. For example, you could split your annual savings allocation like this:

• Cash ISA: £10,000

• Stocks and shares ISA: £6,000

• Lifetime ISA: £4,000

You don’t have to save the maximum £20,000. You can also vary the amount each year, or choose not to save anything if you prefer or if your circumstances change. 

Who can open an ISA?

To open an ISA, you must be a resident of the UK and over 18 – or over 16 for cash ISAs. They are also available to British Crown servants (e.g. diplomats and civil servants) who live overseas, along with their spouse/civil partner.

You cannot hold ISAs jointly, or open one on behalf of someone else (unless it’s a JISA – see below). 

Can I use an ISA to save for my grandchildren?

ISAs tax free savings explained grandfather and child

Yes, if their parent or guardian has opened a Junior ISA (JISA) in their name. They must be under 18 years old and living in the UK, or be living overseas with their civil servant parent(s). The child can take control of the account when they turn 16, but won’t be able to withdraw from it until they are 18. However, the money belongs solely to them.

There are two types of JISA: cash, and stocks and shares. Children can hold either one or both types of account. For the current financial year, the savings limit is £9,000 in total – regardless of whether they have one or two JISAs. 

Which is better: a cash ISA, or a stocks and shares ISA?

This depends entirely on your personal circumstances and your financial goals – and the timeframe in which you want to achieve them. 

To find the ISA product that works best for you, speak to banks and building societies (you can browse their interest rates and terms online), or contact a financial advisor. Don’t be afraid to shop around: you can often open an ISA with a bank or building society without holding any other types of account with them. 

With interest rates so low, is an ISA really worth it?

ISA tax free savings stocks and shares

Interest rates on savings accounts are currently low, with cash ISAs offering less than 1% interest per annum (a far cry from the heyday of the 2000s, when returns were quite a bit higher). 

Other types of savings accounts, such as Regular Savers, may now offer higher interest rates than cash ISAs – though they don’t keep your money in a ‘tax-free wrapper’. But do you really need it? UK citizens now have a Personal Savings Allowance (PSA), allowing you to receive a sum of tax-free interest each year: up to £1,000 for basic-rate taxpayers, and £500 for higher-rate taxpayers. Additional-rate taxpayers do not receive any PSA. 

Again, your personal situation is paramount: if you are a higher-rate taxpayer with a lot of capital invested in well-performing stocks and shares ISAs, then you will no doubt appreciate the tax-free gains. However, if you pay tax on a basic rate, and hold a cash ISA, you may find that a different savings product is more suitable. 

Has Covid-19 affected ISAs?

For the most part, no – though the rules did change slightly for Lifetime ISAs. For a time, account holders were able to access their money early without incurring a 5% penalty, but the original rules were reinstated on 1 April 2021. 

What happens to an ISA if the account holder dies?

When a person dies, their ISAs become part of their estate – and are subject to inheritance tax and any other such levies. 

However, if your spouse or civil partner dies, you may be entitled to an ‘Inherited ISA Allowance’, which means that your ISA allowance that year will include the funds they left to you – as well as your own personal ISA allowance (currently £20,000). 

Is my money safe in an ISA?

Cash ISAs are covered by the Financial Services Compensation Scheme, up to a maximum of £85,000 – so if your ISA provider fails, your money (up to £85,000 per person, per provider) is protected.

The same level of protection applies to stocks and shares ISAs, if the provider fails. However, stocks and shares investments are riskier than cash. The value of your investment may go down as well as up.

How do I close my ISA?

Contact your ISA provider for instructions. You may be able to close your ISA via online banking, in writing, or over the phone. 

If you have a fixed-rate ISA, you will likely incur a fee or penalty if you close the account or transfer the funds out before the agreed term (usually 1–5 years) – so read up on the T&Cs.

How do I transfer my ISA to another provider?

ISA tax free savings explained senior couple with woman on phone and man on laptop

You can change your ISA provider in order to benefit from better rates or terms – but you must transfer the funds, rather than withdrawing and reinvesting them. Otherwise, you will use up your annual ISA allowance when reinvesting, and lose your tax-free perks. 

To transfer funds, contact the ISA provider you want to move to. After you have completed an ISA transfer form, they will initiate the process. Not every account allows you to transfer funds in, so check first.

What are the best ISA rates for over-60s?

ISA rates are not dependent on age: everybody is offered the same ISA rates, regardless of their age or credit score. 

Do more with Boundless

Boundless members can get access to free and discounted financial services. To find out more, click here. For more information on joining Boundless, visit our dedicated membership page.

This article does not constitute financial advice. 

Photos: Getty Images

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