How much should I put in an ISA? The basics you need to know
Taxes may be on the rise but you can still shelter some of your savings from the taxman using an individual savings account or ISA.
An ISA is the technical term for the label or wrapper that is associated with certain products to ensure any returns are tax-free.
All adults in the UK get a £20,000 annual allowance that can be put into an ISA tax-free.
That means you don’t have to pay tax to HMRC on any interest or profit earned in the account.
Using an ISA can be a great way to save towards a goal such as a mortgage deposit or a wedding – or even just to build an emergency fund or put money aside for a summer holiday – without having to share your returns with the taxman. This means there is more money left for you to enjoy.
Rachel Springall, finance expert at Moneyfactscompare, said: “ISAs are like a traditional savings account, except they protect savers’ cash in a tax-free wrapper.
“ISAs are as much of a staple for savers now as ever before, as since April 2024 it’s possible to open and pay into multiple ISAs so long as savers stay within the £20,000 annual allowance.”
The start of the year is a good time to act as many providers start offering competitive deals such as high interest rates or cashback around March and April – towards the end of the tax year – to entice new customers.
There are a few different types of ISA to choose from.
Cash ISA
A cash ISA is similar to a savings account. You can choose an easy access ISA that allows withdrawals at any time or there are fixed rates that pay higher amounts in return for locking your money away for longer. The interest earned on a cash ISA is fixed for a set period.
Cash ISAs provide certainty as you know what return you will get and there is no risk of losing your money, but rates are typically lower compared to normal savings accounts and often the returns fail to beat inflation, which effectively means you are losing money on your savings.
Charlene Young, pensions and savings expert of AJ Bell, explains: “A cash ISA can only hold cash savings.
“This makes them handy for storing money you might need at the drop of a hat, but they may be vulnerable to the effects of inflation if prices are rising faster than the interest rate it’s paying you.”
You can also put your money to work by investing and earning any returns tax-free.
A stock and shares ISA lets you invest some or all of your £20,000 allowance in shares or funds, plus the returns are typically higher than cash and beat inflation, which can be a more efficient and rewarding use of your money and help you reach your savings goals faster.
Young says: “A stocks and shares ISA is an investment account that could grow your wealth and protect it from inflation. They are better suited to longer-term goals, such as investing for school or university fees, to pay off a mortgage, or to boost your retirement pot.
Holly Mackay, founder of investment guidance website BoringMoney, says a stocks and shares ISA is the “no brainer” place to start for anyone who wants to invest.
She adds: ‘We can put anything between £1 and £20,000 into this tax-free account every year, but they are also flexible so you can take the money out if you need it. If you’re a bit nervous about investing, you can always start with say £100 and have a cash ISA too. And ease your way in.
“Even the stuffy world of finance is not immune to technology and it’s now easier than ever to open a stocks and shares ISA online. If you don’t really know what you are doing, look at a ‘robo adviser’. They will ask you a few simple questions and guide you into a pre-assembled collection of investments.”
Lifetime ISA
A third option is a lifetime ISA (LISA).
This is a dedicated tax-free savings product that can be used to save money for a mortgage deposit or for your retirement. The LISA pays a 25% government bonus on what you save towards your first home deposit or want to top-up on your retirement fund.
There are a few restrictions though. It is only open to people aged 18-39 and you can only put up to £4,000 into the product each tax year, which comes from your £20,000 allowance. You also need to be purchasing your first home and the maximum value is £450,000.
Young says: “Because of the free money on offer, there are extra rules that mean this account won’t be right for everybody. You can withdraw the money to buy your first property or once you’ve reached age 60 but if you take the money for any other reason, you’ll pay a hefty 25% exit penalty.”
Junior ISA
There is also a separate ISA allowance that you can use to save for your children
Parents can put up to £9,000 into a cash or stocks and shares Junior ISA account for their children that can only be accessed from the age of 18.
How to use your allowance
You are free to use your ISA allowance across the different types of ISAs.
Some savers also benefit from a personal savings allowance (PSA) that lets basic rate taxpayers earn £1,000 in interest before paying tax on their savings product, dropping to £500 for higher-rate taxpayers.
Springall says: “Those savers who have a PSA to utilise may feel it’s not worthwhile to use an ISA, but recent years have proven their worth. As interest rates grew, so did the need to protect savings interest from tax.
“Higher-rate taxpayers earning more than £500 in interest will breach their PSA, so an ISA is an effective way to protect returns from tax.”
ISA holders can also transfer their pots from previous tax years to products paying higher interest. This is also an option if you want to boost your stocks and shares ISA account and keep the tax-free wrapper.
Some ISAs may even be ‘flexible,’ which means you can add, remove and replace new contributions during a tax year without impacting your annual allowance.
Springall adds: “Not every ISA provider allows this, so savers need to check the terms and conditions carefully. ISA holders must never encash their pots without thinking it through, unless they desperately need the cash, as it will lose its tax-free status.”
When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
