Since their introduction in 1999, ISAs have offered Brits a tax-efficient way to save and invest for the future, and they’re as popular as ever. Indeed, data from FTAdviser shows that a record £9 billion was invested in ISAs in April 2023.
Each tax year, you can contribute your wealth into ISAs up to an allowance, which stands at £20,000 as of 2023/24. This counts for contributions across all ISAs you hold.
Better yet, ISAs have a “tax wrapper” that protects your wealth from Income Tax, Capital Gains Tax (CGT), and Dividend Tax. As a result, ISAs are seen as highly tax-efficient.
However, one of the critical decisions you’ll likely face when you open an ISA is figuring out which type would best suit your current situation. Some of the most common forms include:
- Cash ISAs
- Stocks and Shares ISAs
- Lifetime ISAs
- Junior ISAs
Each type comes with various benefits and downsides, so continue reading to discover the differences between the most common ISAs so you can figure out which would work best for you.
1. Cash ISAs
A Cash ISA works much like a traditional savings account where you save money and earn interest, perhaps making it one of the simplest forms of ISA available.
Though, Cash ISAs differ from traditional savings accounts when it comes to tax, as any interest you earn on your savings is free from Income Tax.
Better yet, there’s no risk to any capital you hold in a Cash ISA, as your money is not invested in the markets. Furthermore, the Financial Services Compensation Scheme (FSCS) protects wealth up to the value of £85,000 held with a single provider in the event of insolvency.
It’s worth noting that if the rate of inflation is higher than the rate of interest you receive from your Cash ISA, your savings’ purchasing power could be eroded in real terms.
That said, there is generally no uncertainty involved with holding your wealth in a Cash ISA. No matter how financial markets move, your savings will continue to accrue interest, which could help you secure much-needed peace of mind.
2. Stocks and Shares ISAs
Rather than simply just saving your wealth, a Stocks and Shares ISA allows you to invest in a range of assets such as stocks and shares, funds, and bonds.
Like other ISAs, Stocks and Shares ISAs are tax-efficient, meaning any returns you generate are free from CGT and Dividend Tax, while your wealth is safe from Income Tax.
Perhaps the most significant benefit of this is that you could potentially generate much higher returns than you would have received if you had relied solely on interest from a Cash ISA. This could help you outpace inflation and maintain the purchasing power of your wealth.
It’s important to note that all investing carries risk, and periods of volatility could reduce the value of your investments. Despite this, it’s worth remembering that evidence shows that long-term investing tends to offer positive returns.
Indeed, data from Nutmeg shows that, in the 50 years between 1971 and 2021, the probability of loss on equities in developed markets dropped to almost 0% if you held an investment for 14 years or more. This data even includes periods of considerable uncertainty, such as high inflation in the 1970s and 1980s, and the 2008 financial crisis.
While past performance isn’t an accurate indicator of future performance, this data can be a source of reassurance, showing that holding onto your investments for an extended period could help you generate returns over time. You could do so tax-efficiently in a Stocks and Shares ISA.
Your capital is at risk. The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested.
3. Lifetime ISAs
If you’re aged between 18 and 40, or you have a child in this age bracket, then you may want to consider a Lifetime ISA (LISA).
LISAs are available in either Cash or Stocks and Shares form, and are specifically designed for saving a deposit on a first home, or towards retirement.
One difference between LISAs and other accounts is that you can only contribute £4,000 to one in a single tax year, and anything you contribute forms part of your overall £20,000 ISA allowance. This means that if you contribute £4,000 to your LISA, you can only deposit £16,000 between your other ISAs in the same tax year.
Crucially, though, when you contribute to your LISA, the government tops this up by 25%. This means that you can essentially earn £1,000 in government bonuses each year if you contribute the full £4,000.
Despite this benefit, it’s important to remember that you can only use wealth in a LISA for your retirement or the deposit for a first home. If you attempt to withdraw funds for anything other than buying a first home or before you reach the age of 60, you’ll typically face a 25% charge.
So, since your wealth is “locked away” in a LISA, it’s vital to ensure that you or your child can afford to save in one, especially when prices are rising and markets are uncertain.
4. Junior ISAs
If you like the sound of helping your children save and invest for their future but don’t want their wealth locked away in a LISA, then a Junior ISA (JISA) could be for them.
After their introduction in 2011 to replace Child Trust Funds, JISAs are as tax-efficient as their adult counterparts.
You can save for your child in a Cash JISA or invest for their future through a Stocks and Shares JISA, and then when your child reaches the age of 18, they can access the funds held within. This wealth could help them afford milestone purchases, such as their first car, university fees, or to get onto the property ladder.
JISAs have a separate allowance, standing at £9,000 in the 2023/24 tax year. Crucially, it’s important to remember that this is in the name of your child, so you can make the most of both your adult allowance and your child’s JISA allowance.
It may be prudent to consider a combination of ISAs
While there are several different ISAs on offer, each with their own set of benefits, nothing is stopping you from opening multiple accounts and dividing your ISA allowance between them.
For instance, you could save £4,000 in your LISA and benefit from the £1,000 bonus, save £6,000 in your Cash ISA, then invest the remaining £10,000 in your Stocks and Shares ISA, all in a single tax year.
This would mean you’re contributing to a specific long-term goal, namely retirement or the deposit for a first home, through your LISA. Meanwhile, you’d be generating reliable interest from your Cash ISA, which you could use for your shorter-term goals, while any returns from your Stocks and Shares ISA go towards other targets.
Get in touch
Above all, it’s worth speaking to a financial adviser. We could review your entire financial situation and make bespoke recommendations for you tailored to your life and goals for the future.
To find out more, please contact us by email at info@investmentsense.co.uk or call 0115 933 8433.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The Financial Conduct Authority does not regulate Tax Advice.
