Financial Mortgage Advice

The Different Types of ISA Explained

What is an ISA?

An ISA is a tax free savings or investment account, which stands for individual savings account (ISA).

Each tax year you have an ISA allowance that lets you save or invest money up to a certain amount without paying any tax on your returns.  For the 2021/22 tax year the ISA allowance is £20,000.  This allowance is for how much you can pay into an ISA, there is no limit to the amount that can be in an ISA.

The UK tax year runs from the 6th April to the 5th April the following year, this means you have until the 5th April 2022 to use up your ISA allowance for this tax year.  When a new tax year starts you will have a brand new ISA allowance. This happens on the first day of every new tax year.

You cannot carry forward any unused ISA allowance from one year to the next.  If you do not use all of your ISA allowance before the end of the tax year it will be gone.

You can find more about what ISAs are in our other ISA article – What is an ISA?.  This article will explain what the different types of ISA are and when you might use one.

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Cash ISAs

Cash ISAs are savings accounts similar to any standard bank or building society account, but without the requirement to pay tax on the interest earned. Account types include easy access, notice and fixed rates.

The interest you receive will vary according to the institution offering the account and how long you are tying your money up for.

The money that you deposit in a cash ISA will not be lost, unless the provider chosen goes out of business. Even then, this risk can be avoided by ensuring you do not place more than the Financial Services Compensation Scheme (FSCS) limit (currently £85,000 per person) with any one provider or providers which share a banking licence.

The way cash ISAs work is arguably the simplest to understand, but the plethora of new types of cash ISA available and the introduction of the Personal Savings Allowance (PSA) in 2016, has added to the level of complication savers must find their way through. So, we will take each of the different types of cash ISA in turn:

Cash ISAs - Fixed Rate

Fixed rate cash ISAs offer a fixed rate of interest for a specified term, usually between one and five years.

While most Fixed rate cash ISAs will allow you to access your funds before the end of the chosen term, you will usually have to pay a hefty penalty to do so and in some cases this will mean having to close the account or transfer it to another provider.  There are a small number of accounts that allow you a limited number of penalty-free withdrawals, but if you go over this amount, penalties will apply. Fixed rate cash ISAs are more suitable for those who do not need access to their money and are happy to tie it up for the term.

Usually the rates are higher the longer the term you choose, but you must make sure that you are comfortable to tie your funds up for that length of period.

Cash ISAs - Variable Rate

If you choose a Variable Rate Cash ISA, you can access your money straight away or choose a notice account, which means you have to wait a set period before you can withdraw your money without penalty. Often, but not always, notice ISAs will pay a higher rate of interest.

Easy access ISAs usually offer unrestricted access to your money, but there are a number of accounts on the market that restrict the actual number of withdrawals you can make each year. Falling foul of the rules could see your interest rate plummet, so it is important to check the small print before choosing these accounts.

If you choose a cash ISA with a notice period, expect to see notice periods ranging between 30 and 180 days. Often the longer the notice period required, the higher the interest rate is, but this can vary widely between providers.  It always good to look around and check the rates at different notice periods as there may be a provider that offers a higher interest rate with a much shorter notice period, which gives you more flexibility.

Cash ISA - Regular Saver

Just like standard regular savings accounts, regular saver cash ISAs are designed for those looking to put aside money each month. This could be to save for a specific purpose, such as a car or holiday, for a rainy day or just to get into the savings habit.  Saving regularly is a great discipline, but remember that once you pay into this type of cash ISA, you would be unable to pay into another cash ISA in that tax year. However, you would be able to pay into another type of ISA, such as a stocks and shares, Innovative Finance or Lifetime ISA, up to the overall ISA limit.  So, it is important to plan how you will use your cash ISA allowance and if you think that you may pay in a lump sum at any point, to consider a variable or fixed rate ISA instead.

Stocks and shares ISAs

A Stocks and Shares ISA (also called an Investment ISA) is a type of ISA account which lets you invest without ever paying income tax or capital gains tax on any investments you make, or on any interest your cash earns. If the stocks or funds in your ISA pay out dividends, you won’t have to pay tax on these either.

This provide a tax-efficient wrapper to hold various types of investments, including shares, unit trusts, investment trusts, exchange traded funds (ETFs), corporate and government bonds.  A stocks & shares ISA should be seen as a medium to long-term commitment, meaning you should be prepared to invest for at least 5 years, preferably longer.  As with any investment, the value of your stocks and shares ISA could go up and down over time and you may you may get back less than what you invest.

If you would like more information about stocks and shares ISAs or if you’re not sure which investments are right for you, then get in touch with us for some Investment Advice.  We can help demystify the investing world and, based on your circumstances and goals, we can help determine what funds and investment account would be most suitable.

Lifetime ISA

The most recently introduced type of ISA is the Lifetime ISA (LISA), which has been available since April 2017. You can choose between holding your funds in stocks and shares and cash or having a mixture of the two types, however you can only pay into one LISA per tax year.

A LISA is available to be opened by those aged between 18 and 40 and is designed to assist younger savers to put money aside for the purchase of their first property or for their retirement.

You can save up to £4,000 in a LISA per year and the Government will add a 25% bonus to funds saved, up until the age of 50. Therefore, you could receive up to £1,000 per year towards your future goals.

The first option is to use the savings held in the account and the bonus earnt to purchase your first home, up to a maximum property value of £450,000. LISAs are not limited to one per home, so two people purchasing together can each use a LISA and receive a bonus in their own right.

If you do not use the funds to buy your first home, you can take out the funds penalty-free after your 60th birthday to go towards your retirement fund.  You can take funds out of the LISA before the age of 60, but if this is not for the purchase of your first home, you will lose any bonus accrued so far, plus any growth or interest received on the bonus.

The LISA is an interesting option for younger savers as it allows you to start building up your savings for a home or your retirement, without having to decide at the outset. It follows on from the Help to Buy ISA as it offers an incentive to save in the form of a Government bonus, but also caters for those already on the property ladder or planning for their retirement.

It is also important to note that if you have both a LISA and a Help to Buy ISA, you can only use the bonus from one of them for the purchase of your first home.

LISAs can be used in addition to a pension, so individuals will be able to contribute to both.  However, you would be wise to seek advice from an independent financial adviser for individual retirement planning, as using only the LISA may not be the best option, especially if you are eligible for a workplace pension.

Many providers are yet to offer a LISA, but hopefully the market will open up over time.

A LISA is not a risk free product and the value of any LISA investment may be at risk due to the investments held within the wrapper.

Junior ISAs

Junior ISAs were introduced in November 2011 and they were originally only available to children born on or after 3 January 2011, or born before September 2002, or those that did not qualify for a Child Trust Fund (CTF).

They replaced CTFs, but unlike the CTF there was is Government contribution to a Junior ISA.  It was initially not possible to transfer a CTF to a Junior ISA, which meant that some children were stuck in these accounts, while providers focused their attention (and the best rates) on the newer Junior ISAs.  That rule changed in April 2015, and now CTFs can be transferred which gives those children the chance to access to the higher returns available.

You can open a Junior ISA for your child from birth and it is run by the parent or guardian until the child reaches 16, when he or she can take control of the account until they are 18.  No withdrawals can be made from the account until the child reaches 18. You can only hold one Junior Cash ISA with one provider, although you are able to transfer it to an alternative if a better option is available elsewhere.

You can choose between Stocks and Shares and Cash for the investment or a combination of the two, up to the Junior ISA limit. In the current tax year (2021/22) the limit is £9,000 and, once opened, the account can be topped up each tax year by parents, friends and family up to this limit.

Once the child reaches 16, he or she is able to open a Cash ISA in addition to a Junior ISA, benefiting from both allowances in that tax year.

Typically, interest rates on Junior cash ISAs are higher than on adult cash ISAs and it can be a great way of building up funds for a child’s future both for parents and other family members, giving them a great start to adult life.

A JISA is not a risk free product and the value of the JISA investment may be at risk due to the investments held within the wrapper

Innovative Finance ISA

This type of ISA, launched in April 2016, enables those interested in peer-to-peer (P2P) lending to undertake this through a tax free ISA wrapper and make sure their interest payments and capital gains will be free of tax.

You can now use some or all of your £20,000 a year ISA allowance to invest in peer-to-peer lending. This is where you make loans to businesses or individuals and receive interest in return.

Peer-to-peer lending can seem particularly attractive when interest rates on savings are so low but, as with any loan, there is always a risk the borrower might not repay.  Some peer-to-peer lenders reduce this risk by spreading customers’ money across multiple loans and running a reserve fund to help cover losses.

The Personal Savings Allowance includes interest paid on peer-to-peer lending, so you don’t necessarily have to open an innovative finance ISA to get your interest tax-free.

Help to Buy ISA

Help to Buy (HTB) ISAs were introduced in December 2015 and were available until November 2019. They are cash ISAs that were designed to encourage first time buyers to save money on a regular basis for their first home.

The account was available to all first-time buyers aged 16 and above. Up to £200 per calendar month can be saved in the account, with an initial opening deposit allowed of up to £1,000 in addition, meaning that a total of £1,200 could have been invested in the first month.  The Government will top up the amount saved by 25%, subject to a minimum bonus of £400 and a maximum of £3,000, so there needs to be a balance of at least £1,600 to earn the bonus at all.

The bonus is paid via the solicitor or conveyancer on completion of a UK property purchase, which must be used as a main residence, with a maximum value of £250,000 (or £450,000 in London).

As with any cash ISA, interest will be paid tax free and if a property is being bought in joint names and both are first time buyers, they were both able to open an HTB ISA, potentially accruing double the amount and double the bonus.  However, it is worth noting that the bonus on a Help to Buy ISA will not be available indefinitely. If you opened one before 30 November 2019 then your bonus must be claimed by 1 December 2030.

You can only pay into one HTB or cash ISA in any tax year.  Anything more will need to be transferred into a stocks and shares ISA, Innovative Finance ISA, Lifetime ISA or moved into a non-ISA account, according to the rules. However, some providers offer portfolio ISAs, allowing those who want to use their full cash ISA allowance to pay into more than one type of cash ISA with them. The generous bonus from the Government was a great incentive for first-time buyers to start putting money aside, even if the prospect of buying a house was still some way off. 

Final thoughts

This article has covered a range of different types of ISA:

  • Cash ISA (Fixed rate, Variable Rate, Regular Saver
  • Stocks and Shares ISA
  • Lifetime ISA
  • Junior ISA
  • Innovative Finance ISA
  • Help to Buy ISA

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