Untangling knotty choices around ISAs

Tom McPhail of The Lang Cat | Supplied

Most people recognise saving money is a good idea – whether to have an emergency cash reserve to draw on, build up a deposit for a house, save for retirement, or some other purpose – and Individual Savings Accounts (ISAs) are the logical choice for millions.

However, it quickly gets more complicated due to the range of different ISAs available, all with different characteristics. In fact, the choice has become so broad, there are growing calls in the savings industry for the government to reduce the number of ISAs on offer.

Investment platform AJ Bell has been campaigning on this issue and has written to the new Chancellor Rachel Reeves, asking her to take action.

In the meantime, why are ISAs so good, what are the choices, and how can you go about picking the best type of ISA for your needs?

The key advantage of ISAs is that they are tax free. Any cash interest you earn, any dividends or capital gains you make, are all tax exempt and you’re free to take money out at any time – you don’t even need to tell HMRC.

After that, though, it starts to get more complicated. There are eligibility restrictions and limits on what the different ISAs offer.

If you’re under 18, then it’s a Junior ISA for you (or more likely, one of your children). The money can’t be accessed until age 18 and Junior ISAs can be invested in either cash or stocks and shares. The maximum amount you can pay in during a tax year is £9,000.

From the age of 18, you have four different ISAs to choose from, three of which are distinguished by what investment choices they offer and one designed for specific savings purposes.

The three different investment types are the Cash ISA, the Stocks and Shares ISA, and the Innovative Finance ISA. They all allow you to pay in up to £20,000 in a tax year.

The Cash ISA invests in cash accounts, with either immediate access or a notice period – which usually pay a higher interest rate. They are low risk and generally more suitable for money you might need sooner rather than later – say, less than five years – or with a sum you just don’t want to take any risks with.

The Stocks and Shares ISA allows investment directly into shares in individual companies or in funds which then spread your money across multiple company shares. This is a higher risk option, which should deliver higher returns in the longer term, but which can lose money and so are better suited to savings terms of at least five years.

The Innovative Finance ISA allows you to invest in peer-to-peer lending, which can deliver higher returns than a Cash ISA but also comes with more risk; you can lose money as well as make it and, at times, there may be a delay in being able to take money out.

Finally, there are Lifetime ISAs, which are a bit different. They are only available for those aged 18-50 and for anyone over the age of 40, you can only pay into one if you started it before that age. The amount you can save is lower – a maximum of £4,000 – but for every £4 you put in, you’ll get a £1 top up from the government, which makes them a pretty attractive proposition.

The catch is, they’re designed for either buying your first home, or saving for retirement; take the money out for anything else and you’ll pay a penalty of slightly more than the original government top up.

You can invest your Lifetime ISA in either stocks and shares or  cash, with the former being better suited to retirement saving and the latter for building up a house deposit. If you save in a Lifetime ISA, you can also use one of the other ISAs, but the overall limit of £20,000 will be reduced by whatever you put in your Lifetime ISA.

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