ISAs can be a great way of saving tax-free for your future and they are relatively straightforward to understand. However, to get the most from your annual ISA allowance, it is important to understand the different types of ISAs available, how they work, and what their benefits are.

There are 3 types of ISA available in the UK: Junior ISAs, Lifetime ISAs, and traditional ISAs, and your annual ISA allowance varies depending on where you decide to save your money.

What is the ISA allowance or limit?

The current ISA allowance (also known as the ISA limit) for 2020/2021 is £20,000. This allowance can be split between one cash ISA, one stocks and shares ISA, an innovative finance ISA, or a lifetime ISA.

ISA allowances are usually increased every year, with the new allowance being announced as part of the Government’s budget.

Junior ISAs

UK residents under 18 years old have an ISA limit of £9,000 which they can pay into a Junior ISA.

This allowance can be saved into a cash Junior ISA, a stocks and shares Junior ISA, or split between the two.

Combined allowance

If you are aged over 16 but under 18 you can therefore benefit from a combined ISA allowance of £29,000. This is made up of £20,000 from an adult ISA and £9,000 from a junior ISA.

Save for a property or retirement with a Lifetime ISA

In addition, UK residents aged between 18 and 39 can choose to pay £4,000 of their £20,000 ISA allowance into a Lifetime ISA (LISA). This means you can only pay the remaining £16,000 into traditional ISAs. 

The Government offers a 25% bonus on any money saved in a LISA to those who use the money to buy a first property, or to save for retirement. 

So, if you save the full £4,000 in a year, this will be topped up to £5,000. This can be a worthwhile scheme to help you get on the housing ladder, but is only available to those who have never owned a property anywhere in the world before.

Should I use my ISA limits?

ISAs are popular as they allow you to save and earn interest tax free, and do not need to be declared on your tax return. ISA savings are also protected from being taxed both now, and in the future.

Lifetime ISAs, in addition, offer a great financial incentive to those wishing to buy a home.

Cash savings

However, changes to the way standard savings (i.e. non ISA savings) are taxed have undermined the value of Cash ISAs to some degree.

Personal savings allowance

Beginning in April 2016, basic (20%) and higher (40% or 41% in Scotland) rate taxpayers received a new personal savings allowance that applies to interest earned by your bank account deposits.

  • Basic rate (20%) £1,000 allowance

  • Higher rate (40%, 41% in Scotland) £500 allowance

  • Additional rate (45%) No allowance

This means if you’re a basic rate taxpayer, you can earn up to £1,000 in savings interest tax-free, even outside of an ISA. 

Even if you were to earn a very generous 5% interest, you would need £20,000 in savings to exceed this new allowance. 

Of course, many people are not in this position, so the question becomes one of ‘which savings product will deliver the highest return: ISA or standard savings account?’

Rates vary regularly, but for the most part, standard savings accounts (and increasingly current accounts) often offer the best savings returns, so it could be more lucrative to put your cash in the best paying savings account rather than a Cash ISA.

Stocks and Shares ISA

Finally, if you are a keen investor, doing so within a stocks and shares ISA wrapper means that you won’t pay Capital Gains Tax (CGT) on your gains, and your dividends will be paid tax free, which can save you a significant sum over long investment periods.

27 January 2021