Individual Savings Accounts or ISAs are a place where you can put a range of savings and investments.
However, you don’t pay any tax on the interest or income you earn. There are two types of ISA:
- a cash ISA
- an investment ISA (also known as stocks and shares ISAs)
All the interest you earn from a cash ISA is tax free.
With an investment ISA, most of the income you earn from it will be tax free, but if you choose a share-based investment, the money you make on the shares is taxed.
Who can save in an ISA?
You have be resident in the UK to be able to open an ISA.
You can open a cash ISA from age 16 or over and you can open an investment ISA from aged 18 or over.
What’s the difference between a cash ISA and an investment ISA?
Cash ISAs are a good way to save for the short-term. This is normally less than 5 years. They usually offer good rates of interest compared to bank and building society accounts with the added bonus that you don’t pay tax on the interest.
Investment ISAs are for stock market investments. They are worth considering if you want to save for longer than five years and are willing to take a risk with your money.
Investing in the stock market is a riskier way to save because it’s possible to lose money as wellas make it. However, the longer you invest for, the more likely you are to make more money than if you had saved with a bank or building society. This is called giving you a higher return.
You can switch the money you have in a cash ISA into an investment ISA but you can’t put money from an investment ISA into a cash ISA. So if you’re thinking of switching to an investment ISA, remember you won’t be able to put it back into a cash ISA if your investment does not do as well as you hoped.
If you want to switch to a different ISA, your ISA provider has to do that for you and may charge you.
If you are interested in putting your money into an investment ISA, you might want to get help from an FCA regulated financial adviser. They will help you to decide whether this is the right choice for you.
Cash ISAs vs. Stocks & Shares ISAs
There are four types of ISAs available for your savings and investments. You can open a Cash ISA, a Stocks & Shares ISA, a Lifetime ISA and an Innovative Finance ISA.
All provide a tax-efficient way to save whether you decide to invest a lump sum or top up your ISA with a regular monthly payment. Below, we explain the pros and cons of each.
Cash can form a good basis for a portfolio – unlike stock market investments, cash savings can offer immediate access and the capital is secure.
Cash ISAs operate just like a normal savings account except all the interest is tax free. The interest rate offered in a Cash ISA will vary based on which provider you choose. Therefore, it’s essential to shop around for the best deal using the best buy tables which can be found in the press or online. Watch out for headline-grabbing introductory rates or temporary bonuses though, as when these disappear you could be left with an unattractive rate.
However, with such meagre interest rates available at present, there is a high price to pay for security. In the long term opting for this security can be a bad move, because low-risk, low-return investments will be disproportionately hit by inflation. Even historically low inflation of 3% will almost halve spending power over 22 years. Once some cash savings have been built up ‘for a rainy day’, investors could consider investing in riskier assets which offer higher potential returns, although they will fall in value as well as rise and don’t offer the same security as cash.