There’s an Isa for every saver, but determining which one is right for you isn’t always easy.
The Isa family has grown over the years, so there are now five different types to choose from.
They’ve been around for 24 years, with various new additions along the way. All Isas are designed to help you protect and grow your wealth. But each will help you with different goals.
Decision time: there is an Isa for every saver, but determining which one is right for you is not always easy
Build a rainy day fund
Cash Isas are perfect if you are growing a small nest egg or want a house to save that you will need in the next few years.
They work much the same as a standard savings account. You open an account, pay in cash and receive interest in return.
As with all savings accounts, some Cash Isa allow you to access your money whenever you want and without notice, while others lock your money in for an agreed period of time.
The only key difference between Cash Isas and other savings accounts is that in the former case all interest earned is tax exempt.
Cash Isas had fallen out of favor in recent years and savers were just as happy to put their money in a standard savings account.
This is because they earned so little interest that few of them had to pay taxes anyway.
All savers have a personal savings allowance in addition to any Isa they hold. Savers who are basic rate taxpayers can earn up to £1,000 in interest tax free, while higher rate taxpayers can earn up to £500. For the most part, that was enough.
But as interest rates have started to rise, it is now much easier to breach the Personal Savings Allowance and Cash Isas are showing their value again.
For example, if a higher rate taxpayer puts £20,000 into a standard savings account paying 3%, they could end up with a tax bill of £40. But if they save the same amount in a Cash Isa, they will not pay any tax.
Which Cash Isa is right for you will depend on why you think you need to withdraw your money.
If you need it immediately, an easy-to-access account is best. The best rates on these are currently just above three percent.
If you won’t need your money for a while, you may be better off with a fixed rate cash Isa, which ties up your money for a few months or years.
The longer you stay, the better rate you will likely get.
However, the rewards for fixing for a few years aren’t much greater than for one or two, so you might not think it’s worth fixing any longer.
You can currently get a one-year fixed rate bond yielding over four percent. The best five-year fixed-rate Isas now pay around 4.2%.
Look long-term to grow your wealth
Cash Isas are great for the money you want to access over the next five years. But if you can lock in your savings for at least five to ten years, a Stocks and Shares Isa may be a better option.
Over most periods, investing has proven to be more lucrative than earning interest on savings.
For example, if you had invested in a globally diversified portfolio of companies since 2005, you would have earned about 10% per year on average. If you had left your money in a savings account, you would have earned about 1.5% per year on average.
However, investing requires a special mindset. With cash savings, you know exactly how much you have in the bank at all times.
With investing, the amount you have available varies from day to day. You must be able to accept that you could lose money and that there is an element of risk involved.
Gloucestershire IT quality assurance manager Beth McCarthy, 31, started investing using an Isa four years ago. “There are a few things I try to achieve,” she says. “I’m a thrifty person and I like knowing I have a nice cushion behind me just in case. I would also like to save for the next move, whatever it is. And finally, I’m building a comfortable life for retirement.
Beth opted for an Isa rather than a general investment account so she could keep more of her returns to accelerate the growth of her nest egg, rather than having to hand over some of it to the taxman.
You can open and manage a Stocks and Shares Isa through an investment platform or through a bank. Which one is best for you will depend on how much control you want to have over what you invest in, which one offers the best value for money, and what level of customer service you will need.
For a great overview of the options available on our partner website This is Money, go to thisismoney.co.uk/platform.
Don’t be discouraged if you’ve never invested before. There are a growing number of options designed for novice investors. These don’t require you to choose funds, forecast the economy, or buy and sell stocks. You simply indicate the level of risk you feel comfortable with and how long you need to invest, and then you receive a portfolio that meets your needs.
If you are saving for your first home
A Lifetime Isa can help give your savings a significant boost if you are considering buying your first home. There are two types: one keeps your cash savings and the other invests them.
Lifetime Isas can be very generous for some savers. However, there are very strict limitations.
Want a house? A Lifetime Isa can help you significantly increase your savings if you are planning to buy your first home
Matilda Littler, 27, a project manager from Hertfordshire, opened a Lifetime Isa to help save for her first home. She receives a bonus from the government on top of whatever she is able to save herself.
“I’ve had my Lifetime Isa for about three years and got £3,000 as a bonus from the government,” she says. “I also enjoy an interest rate on my savings of 2.85 percent.”
In anticipation of your retirement
Pensions are probably the best option for most people saving for retirement. Occupational pensions allow you to benefit from both tax relief and contributions from your employer.
However, if you are self-employed and therefore do not have a company pension or wish to supplement your company pension, a lifetime ISA may be useful.
They are designed to support retirement savings, as the money saved can only be used for your first home or when you reach the age of 60.
Read our Lifetime Isa guide for more information.
Saving for your child’s future
Children can also have their own Isa. The Junior Isa (Jisa) can be opened from birth until the child is 18 years old.
Annual deposits are limited to £9,000 and the money is not accessible before the age of 18. Protecting a child’s money from tax may seem strange, but it is subject to the same tax rules as adults.
Additionally, if a parent deposits money into a child’s account and earns more than £100 in interest, anything over £100 will be taxed at the parent’s income tax rate.
Putting their savings in a Junior Isa means you don’t have to worry about tax today, and as their nest egg grows, you know it will always be tax-free.
Junior Isas automatically turn into adult Isas when the child turns 18.
You can choose from a Junior Isa cash or investment or have one of each. Because money is locked in for the long term, a Junior Isa investment offers the best opportunity for growth in nearly two decades.
“One of the main benefits of a Junior Isa is that any capital gains or dividend income on investments will be protected from tax,” says Alice Guy, personal finance editor at Interactive Investor.
“It could potentially save thousands of dollars over time, especially once a child becomes an adult and starts paying their own taxes,” she adds.
For something a little different
The latest member of the Isa family is Innovative Finance Isa.
These accounts allow you to invest your Isa allocation in peer-to-peer (P2P) loans. This means that your money is lent to borrowers who pay it back to you in installments plus a fixed amount of interest.
An innovative finance Isa can offer much higher interest rates than a cash Isa.
For example, Crowd2Fund announces an annual return on its IF Isa of 11%.
But you take a lot more risk. You could lose your money if a borrower defaults.
These Isas are not covered by the Financial Services Compensation Scheme (FSCS), which means that if the P2P company goes bankrupt, you may not get your money back.
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