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 ISA allowance, it’s important to understand what types of ISAs are available, how they work, and what their benefits are.
There are three 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.
Your ISA allowance or limit for 2019/2010 is £20,000, which you can 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.
UK residents under 18 years old have an ISA allowance of £4,368 which they can pay into junior ISAs. Therefore, children aged over 16 but under 18 have a combined allowance of £24,368 – £20,000 for traditional ISAs and £4,368 for junior ISAs.
Also, people aged between 18 and 39 can pay £4,000 of their £20,000 allowance into a lifetime ISA. This means you can only pay the remaining £16,000 into traditional ISAs. However, given that the government offers a 25% bonus on money saved in a lifetime ISA, this can be well worth it – especially if you’re saving for a property or looking to use a lifetime ISA to help fund your retirement.
ISAs are popular because they let you save money and get tax-free interest. However, changes to the way standard savings (i.e. non-ISA savings) are taxed have undermined their value to some degree.
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. Assuming you received 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) offer the best savings returns, so these should usually be maximised before using an ISA – unless you are particularly keen on a riskier stocks and shares ISA.