How to decide which ISA account is right for you

If you’re wondering where to put your savings, you may be considering taking out an ISA.

An ISA (Individual Savings Account) allows you to put away up to £20,000 each year without paying tax on any gains you make.

That means your earnings will be exempt from things like capital gains tax and dividend tax. Below, we explain how.

There are four types of ISA you can take out – cash ISA, stocks and shares ISA, lifetime ISA and innovative finance ISA.

You can also open a Junior ISA to save or invest on behalf of your child.

A cash ISA is essentially a savings account where you don’t need to pay tax on the interest.

The stocks and shares ISA allows you to invest in funds, bonds and shares in individual companies – but again, you don’t pay dividend, capital gains or income tax on any gains or income from these investments.

Both of these ISAs allow you to deposit up to £20,000 each tax year into them as part of your allowance.

The lifetime ISA (LISA) lets you save up to £4,000 every tax year towards a first home or your retirement, with the government adding a 25 per cent bonus on top of what you save.

It’s worth noting that you pay a penalty of 25 per cent of the amount withdrawn if you don’t use it for a first home or retirement – which actually works out as a six per cent loss on your savings.

The innovative finance ISA contains peer-to-peer loans, matching up investors with borrowers.

While you tend to earn higher interest rates with these than a traditional savings account, peer-to-peer lending involves considerable risks and several platforms have collapsed in recent years.

With the next tax year starting on 5 April, now can be a good time to start thinking about how to split your money.

Rajan Lakhani, personal finance expert at Plum, says there are “some brilliant rates out there at the moment which mean you’d be able to beat inflation”.

“It’s worth looking for an account that pays out more than 5 per cent – check out the fintechs or smaller banks as these are more likely to offer a higher-paying rate than your high street bank,” he said.

Although these rates are harder to come by since falling interest rates, they are still available.

Lakhani added that you should always double-check that your cash ISA is protected by the FSCS.

Paul Carlson, managing partner of Law Firm Velocity, says this depends on whether you are more risk-averse or are looking for maximum return.

“If you’re risk-averse, I’d suggest a cash ISA. You can park your money there and earn interest without worrying about taxes eating into your returns,” he says.

“But if you’re looking for growth, I’d push you towards a stocks and shares ISA. You can invest in shares or funds, and all the gains are tax-free. Plus, you don’t have to report these on your tax return.”

Claire Exley, head of advice and guidance at digital wealth manager Nutmeg, says it also depends on how long you are willing to put your money away for.

“It’s worth bearing in mind that if you think you’re going to need the money within the next three years then a cash ISA is likely to be better for you (and it’s worth checking there are no withdrawal restrictions on fixed rates),” she says.

“If you have a longer-term goal in mind, then investing in stocks and shares could offer you the opportunity to beat inflation.”

It’s worth noting that investing in stocks and shares does carry risk, and you won’t necessarily make any returns – or could even lose money.

If you’re saving for your first home, the Lifetime ISA can be a good option because you can earn 25 per cent on top of what you put in – but it’s worth bearing in mind the withdrawal penalty if you take the money out for any reason other than a home purchase or retirement.

You can also only use the LISA to buy a property that costs £450,000 or less.

One option is to open multiple ISAs for your different needs.

Brian Byrnes, head of personal finance at Moneybox, said the £20,000 ISA allowance “can be split across different ISA products depending on your financial goals, including a Lifetime ISA if you’re saving for your first home, a cash ISA if you’re saving for mid-term financial goals or a stocks & shares ISA to grow your money over the longer term.”

“The tax advantages of the ISA really cannot be understated, so whatever your savings or investment goals, it’s important to check whether you’re doing it in a tax-efficient way. This may even include moving your savings or investments into a suitable ISA to help save you a hefty tax bill in the future.”

Most banks or investment platforms will let you do this online, and it should take about 10 minutes.

You’ll just need your ID and some personal details to hand.

Once your account is set up, you can transfer money from your bank account or transfer existing savings from another ISA.

Remember, you can’t exceed the £20,000 limit in one tax year.