An ISA is just a wrapper. Whatever you put inside it grows free of income tax and capital gains tax, and you never declare it on a tax return. That is the whole appeal. The confusing part is that there are several flavours, and people tie themselves in knots picking one.
The annual allowance
You can pay up to £20,000 into ISAs in a single tax year, which runs from 6 April to 5 April. You can split that across types however you like, but you cannot exceed the total. Unused allowance does not roll over, so come early April it is a case of use it or lose it.
The three you are most likely to need
- Cash ISA — works like a savings account. Sensible for money you might need within five years or for an emergency fund.
- Stocks and shares ISA — holds funds and shares. Suited to money you can leave alone for the long term, because values rise and fall.
- Lifetime ISA — for a first home or retirement. The government adds 25 per cent on top, up to £1,000 a year, but you pay a penalty if you withdraw for anything else before 60.
Which one for which job
Match the wrapper to the timescale. Rainy-day cash belongs in a cash ISA where it will not wobble. Money for a pension you will not touch for decades has time to ride out the stock market, so a stocks and shares ISA usually wins. If you are saving for your first flat, the Lifetime ISA bonus is hard to beat, as long as the property is within the price cap.
A common mistake
Plenty of people open a cash ISA every year out of habit while paying little or no tax on their savings interest anyway, thanks to the Personal Savings Allowance. If that is you, a plain savings account with a higher rate may serve better. The wrapper only helps when there is tax to shelter.
Start with the job the money needs to do, then pick the wrapper. Do that and the rest falls into place.