Types of ISA: Choosing the best ISA for you in 2018
There are four main types of Individual Savings Account (ISA) available to adult UK residents, all of which act as tax wrappers, allowing you to earn tax-free returns on your savings or investment:
Each tax year (6th April–5th April), you can open and pay into a maximum of one of each type, with total savings capped at the annual ISA allowance (£20,000 for the 2018/19 tax year).
There is also the Lifetime ISA (LISA), which can be held alongside other ISAs, but has a £4,000 annual allowance (which is part of your overall £20,000 allowance), the Help to Buy ISA, which can be held instead of a Cash ISA, and the Junior ISA (JISA), which is designed for under 18s. With so many to choose from, it can be difficult to know where to save or invest your money.
In this guide, we'll talk you through these different types of ISA, and look at some of the factors you need to consider to choose the best ISA for you.
What is a Cash ISA?
Eligibility criteria: You must be aged 16 or over.
Potential returns: Average rate of 0.7%, up to 2.25% for a five-year term (Defaqto, March 2018).
Best for: Easy access, short-term saving.
Cash ISAs are a type of savings account where you are protected from paying tax on the interest earned. With a Flexible Cash ISA or Instant Access Cash ISA, you can withdraw and replace savings as required, making this the ideal choice if you need the freedom to access your money easily.
Fixed-Term Cash ISAs offer better interest rates in exchange for you locking your money away for a certain amount of time. They're a good choice if you can afford to leave the money untouched. If you're able to make monthly contributions, a Regular Savings Cash ISA might be a better fit. Find out more on the Money Advice Service website.
Help to Buy ISAs are classed as a type of Cash ISA but work very differently. Read the section below to find out more. You can also get Cash Lifetime ISAs.
What is a Stocks and Shares ISA?
Eligibility criteria: You must be aged 18 or over.
Potential returns: Average growth of 20.4% in the 2016/17 tax year (moneyfacts), but your money can increase or decrease in value.
Best for: Long-term investment if you have exceeded other allowances.
With a Stocks and Shares ISA, you can earn capital gains, interest on bonds, or dividend income without paying tax. You can invest in individual company stocks or through an investment fund, or a combination of both. However, it's important to remember that you can already earn tax-free capital gains up to the Annual Exempt Amount (£11,700 for 2018/19) and can take advantage of a Dividend Allowance (£2,000 for 2018/19), so this type of ISA may not be worthwhile unless you exceed these limits.
The stock market is volatile in the short-term, but tends to outperform cash in the long-term, so most financial advisors recommend investing for a minimum of five years — ideally ten. However, it's important to remember that past performance is not always a reliable indicator of the future, and there is a risk that your capital will decrease in value. Find out more on the Money Advice Service website.
You can also get Lifetime ISAs that are linked to the stock market.
What is an Innovative Finance ISA (IFISA)?
Eligibility criteria: You must be aged 18 or over.
Potential returns: We currently project 6.0% per annum over five years.
Best for: High interest rates, ethical investing.
IFISAs allow you to enjoy tax-free interest and capital gains through peer-to-peer (P2P) lending. Because they are operated by FCA-authorised P2P lending platforms rather than banks, many people consider them a more ethical type of ISA. This also enables them to offer competitive interest rates.
What is a Lifetime ISA (LISA)?
Eligibility criteria: You must be aged 18 or over but under 40.
Potential returns: 25% bonus (up to £1,000 per year) plus interest or capital gains.
Best for: Saving for retirement or your first home.
With a Lifetime ISA, the government adds a 25% bonus on top of your contributions each month, up to a maximum of £1,000 per year. As it is designed for saving for retirement or a first home, you will pay a 25% charge upon withdrawal unless you are:
- using the money to buy your first home,
- aged 60 or over, or
- terminally ill with less than a year to live.
You can pay in up to £4,000 per year until you're 50. After this time, you will continue to earn interest (on cash products) or investment returns (on stocks and shares products), but will not be able to make contributions or earn bonuses. Find out more on the government website.
Please note that, while you can contribute to both a Help to Buy ISA and Lifetime ISA, you can only claim the first-time buyer bonus from one product.
What is a Help to Buy ISA?
Eligibility criteria: You must be aged 16 or over and a prospective first-time buyer.
Potential returns: 25% bonus (£400–£3,000) plus interest.
Best for: Saving a deposit for your first home.
The Help to Buy ISA is designed to help first-time buyers purchase a home. The government pays a 25% bonus when you withdraw your savings for use as or towards a mortgage deposit. You must purchase a UK property worth £250,000 or less (£450,000 or less in London) to qualify.
You can save up to £1,200 in the calendar month you open your Help to Buy ISA, and £200 per month thereafter. The minimum bonus you can claim is £400 (on savings of £1,600), and the maximum is £3,000 (on savings of £12,000).
The Help to Buy ISA is a type of Cash ISA, which means you cannot pay into both at the same time. If you wish to open a Help to Buy ISA but already paid into a Cash ISA that tax year, you will need to transfer or withdraw these funds. Find out more on the Help to Buy site.
Please note that, while you can contribute to both a Help to Buy ISA and Lifetime ISA, you can only claim the first-time buyer bonus from one.
What is a Junior ISA (JISA)?
Eligibility criteria: You must be under 18.
Potential returns: Up to 3.5% (MSE, July 2018)
Best for: Saving for your child's future.
If you want to save for your child's future, you might consider opening a Junior ISA in their name. You can save up to £4,080 in the 2018/19 tax year, and the child will have access to the savings when they turn 18. Find out more on the government website.
If you gift money to your 16 or 17-year old, remember that you might have to pay tax under the parental tax settlement rules. Visit the HM Revenue & Customs website to find out more.
Choosing the best type of ISA(s) for you
The best type of ISAs for you are those that maximise returns while allowing you to access and spend your money as you desire. Remember that you can invest your annual ISA allowance into one type of ISA, or split it across a combination of products, in accordance with the limits and rules above.
Here are some questions to ask yourself before making a decision.
How much risk are you willing to take?
As a rule of thumb: the riskier the investment, the higher the potential returns. If you cannot afford to lose the money, you should save rather than invest.
Cash ISAs, Help to Buy ISAs and Cash Lifetime ISAs are savings products: your capital is not at risk. The money you deposit is protected, and you cannot end up with less than you put in. However, it's important to remember that below-inflation interest rates can mean that your money loses value over time. Up to £85,000 per institution is also covered by the Financial Services Compensation Scheme (FSCS), which means you are protected should your ISA provider enter default.
Stocks and Shares ISAs, and Stocks and Shares Lifetime ISAs, are investment products, which means that your capital is at risk. Because growth is linked to the performance of the stock market, there is a chance that you will end up with less money than you contributed. Up to £50,000 is protected under the FSCS, but this only covers you if your provider goes bust — not if your investment performs poorly.
Innovative Finance ISA rates generally fluctuate according to the demand for P2P loans, and returns rely on borrowers making repayments. As such, your capital is at risk. However, most platforms have some protections in place to reduce this risk – for example, Lending Works has the Lending Works Shield in place to help protect lenders, a combination of insurance and a reserve fund. We also perform extensive credit, fraud and affordability checks on borrowers to ensure they can afford and are likely to repay their loans. Money contributed to an IFISA is not protected under the FSCS.
What are you saving for?
If you are saving up for a deposit on your first home, bonuses available through the Lifetime and Help to Buy ISAs make these the most appealing options. The Lifetime ISA bonus available if you withdraw over the age of 60 also makes it a smart choice if you're saving for retirement. However, if you do not use these types of ISAs for their intended purpose, the returns are relatively poor — you can even lose money — so it's important to consider the likelihood that you will use your money in this way.
How long are you saving or investing for?
Generally, the longer you are willing to save or invest your money, the higher the returns you can expect. So, if you can afford to leave your money untouched, take advantage of investment ISAs or cash products with a minimum term.
Bear in mind that most financial advisors recommend investing in stocks and shares for a minimum of five years, ideally ten. That's because the market is volatile in the short-term, but tends to offer high returns over the long-run.
What other savings and investments do you have?
Your other savings and investments can affect your ISA benefits. For example, if you're not already taking advantage of tax-free allowances like the:
- £1,000 Personal Savings Allowance,
- £11,700 Annual Exempt Limit, and
- £2,000 Dividend Allowance,
then you are not getting any additional tax benefits from an ISA. If you are saving for retirement, pensions tend to be more effective tax wrappers.
Also, you cannot claim the first-time-buyer bonus from both a Lifetime ISA and Help to Buy ISA so, even if you've maxed the limit on one, opening both for this purpose is unlikely to be worthwhile.
Now that you have identified the best types of ISA for you, take a look at our guide to getting the best ISA rates for more advice on securing the right product.
It is important that we highlight that with any peer-to-peer lending platform, your capital is at risk.