Different Types of ISAs Explained

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Today I’m covering a topic that I get asked about a lot.  What are the different types of ISAs and which is the best type for you. Luckily, we have lots of different options available to us on this front, but that doesn’t make the decision about which ones to get any easier.  If anything it makes it worse.

Plus everyone’s circumstances are different so it is not a straight forward answer and depends on your personal situation. Thankfully that is where I can help.

First up a quick disclaimer, this is not financial advice.  It is education and therefore you need to do your own research or speak to an FCA-regulated Financial Adviser about your specific situation. Also I will be talking about investment options and you need to know that your money can go down as well as up, so make sure you understand the risks.

Now if blog posts are not your things, then do not worry. I also made this into a YouTube video. Check it out. (And don’t forget to subscribe while you are there.)

What are ISAs?

ISA stands for individual savings account.  It is a type of account that you as an individual can open.  You can’t get joint ISAs and everyone gets their own personal allowances. At their simplest ISAs are tax-free wrappers that go around certain savings and investing accounts.   This means that any money you make on the money that you place in these accounts is tax-free. This includes money made from interest, capital gains, and dividends.  

Everyone over the age of 18 gets a personal ISA allowance of £20k for this tax year.  This may go up or down in the future. You can split this across different types of ISAs, but some have rules about the maximum you can pay in. 

Each ISA is designed with a different purpose in mind, and it is up to you to decide which ISA is right for you. There are also junior ISAs available for those under 18, but I have covered this in this article.

Types of ISAs available

Cash ISA

This is essentially a savings account.  You put your money in and you earn interest on it. You are allowed to pay the full £20k into this account and you are normally allowed to withdraw your money from it at any point. If you do this though, you don’t get the allowance back, so bear this in mind before you take money out.

S&S ISA

This is for investing and the types of investments you have access to will depend on the investing platform that you open your account with. Again you can pay the full amount into this account and withdraw at your leisure.  But you don’t get the allowance back.

Lifetime ISAs

There are a few variations on this type of ISA.  You can choose from a cash or a stocks & shares version.  And you can choose what you use it for: first home or retirement.

You can pay a maximum of £4k into these accounts, but they do come with a serious perk.  You get a 25% top-up from the Government on the money that you put in. Plus, you can also earn interest if using a cash version or invest it to grow the money and earn dividends.

Withdrawing money from these accounts means that you will lose the Government bonus and some.  The Government say this is because LISAs are intended as a long-term product.

There are rules around how you can open and use these.  For example, they must be opened before you turn 40.  And they must be open for at least a year before you use them to buy a house. There are also rules around what constitutes as your first home, so make sure you check that you are eligible before you put any money in.

Innovative Finance ISAs

IFISAs are probably the least used and the least talked about types of ISA and probably for good reason. They offer those looking to invest in peer-to-peer lending a way to get tax-free returns.  But they can be riskier.

You can use your full £20k allowance in this type of ISA and the withdrawal rules will depend on the platform that you are investing through.

Choosing the right ISAs for you

Now you are allowed to have one of each that you are paying into each tax year.  So that means that you can’t open 5 S&S ISAs and be paying into all of them at the same time. But you can have a cash ISA, a S&S ISA and a LISA all on the go at the same time.

Now the ones you want to open will depend on your personal circumstances and financial goals. If you want to save your money, without taking any risk and ensuring that you still have access to it if you need it then a cash ISA could be for you. But stick around until the end because it might not be the best choice even for this.

A S&S ISA is best suited for people that are looking to grow their money through investing with the hope that they can get a better return over time than the interest rates offered in savings accounts. They also work well for people looking to access their money before pensionable age. They can be a good way to grow money for events that are further ahead, such as university costs for children or retirement (before 57).

LIfetime ISAs obviously serve very specific purposes.  Let us look at the case of the person that wants to buy a first home. This is normally a medium-term goal.  Say 3-5 years if things work out.  Now, this is probably too short a time frame for investing as the markets can be volatile.  Therefore, a cash LISA might be better.

If you are using a LISA for retirement, then this is likely to be at least 20 years away.  Given that you have to open them before 40 and can’t access them until 60. In this instance, a S&S ISA might work better, but only if you can manage the extra risk and understand the consequences.

For IFISAs, this is a very niche product and unless you are specifically interested in the style of investing they offer, you don’t really need to consider it.

Do you need a cash ISA?

A quick word on cash ISAs.  Although they may seem attractive in the fact that they offer tax-free savings, you are likely getting tax-free interest anyway.

Since 2016, everyone has a personal savings allowance of £1,000.  Meaning that you can earn £1k in interest per year before you have to think about paying tax. This is for money in any type of savings or current account.  So you don’t need to use your ISA for this.

Now given that interest rates are pretty low, it is unlikely that the average person is going to exceed this anyway. Therefore it is more appropriate to hunt out the best interest rates on all types of accounts not just cash ISAs.

This will then keep your £20k ISA allowance free for your investments, which hopefully will generate a larger return.

What other tax-efficient options are out there?

The main one to consider is your pension.  The Government provides some tax relief on any money that you pay in depending on your income tax band. This is particularly important when thinking about LISAs for retirement.  The Government has stated that this type of ISA shouldn’t replace pensions and instead works along side it.

Although some of the money that you pay into your pension will be taxable.  The 25%+ tax relief that you receive now could help your money grow faster. But you won’t be able to access it until you reach at least 55 if not 57.  

It is worth speaking to a Financial Adviser if you want to make sure that your savings, investments and pensions are optimised for your personal situation.

Conclusion

There you have it.  A thorough rundown of the different types of ISAs available and some of the things that you may want to consider when deciding which ones are best for you. As always do your own research, have conversations, check the small print, and decide what will work best for you.

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