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ISA vs Savings Account: Comparing ISA Accounts

When it comes to investing, common questions that many people ask are, “Are ISAs worth it?”  and “Should I get a savings account or ISA?”. While an Individual Savings Account (ISA) or a savings account is a good savings vehicle in the UK, it may not be a suitable choice for everyone, which is why it is important to have the ISA vs savings account debate.

What does ISA stand for?Individual Savings Account
What is the difference between an ISA and a savings account?The difference is that the interests earned in an ISA are tax-free
Which is better, an ISA or a savings account?It depends on your financial goals and risk tolerance
Is a savings account better for long-term goals?A savings account is better for a short-term goal

INVEST IN A STOCKS AND SHARES ISA

What is an ISA?

ISA stands for Individual Savings Account. An ISA is a type of tax-free savings account in the UK that allows you to save or invest money in a tax-efficient manner. The amount of money you can save tax-free in a financial year is called an ISA allowance, and it is one of the advantages of ISA investments. The ISA allowance is currently set at £20,000 per annum. This means you can deposit up to this amount every year and not have to pay taxes either in terms of capital gains or income.

As well as discussing the ISA vs savings account debate, we look into how to make the best use of your savings and why you need to consider both short and long-term savings.

When considering financial planning, doing a comparison between ISA vs savings account is a good place to start. Having enough money to survive daily is the least of your expectations. So, how do we factor in bigger aspirations or the ability to cope when emergencies arise? What about when the source of income dries up? This is why people need to save.

Given that saving is such a crucial part of everyone’s financial lives, the laws of supply and demand have kicked in. The result is that today there are many different ways of saving. This blog will focus on the Stocks and Shares ISA vs savings account option.

Before we get further into the savings account vs ISA discussion, it’s important to understand the different types of savings accounts available.

What is a savings account?

A savings account is a vehicle offered by banks and other financial institutions in which people can deposit money to earn interest.

The rate of interest on traditional savings accounts is currently very low and starts at around 0.5%. However, the main attraction of a savings account is that it allows the saver immediate access to their savings without any prior notice.

Pretty much all saving is a positive financial step, but there are some important differences between the various types of savings accounts. Before we get further into the ISA vs savings account argument, let’s take a look at the types of savings accounts available.

Various types of savings accounts

There are different types of savings accounts here in the UK, and some include.

  • Easy Access Savings Account
  • Notice Account
  • Fixed-Rate Bond
  • Regular Savings Account
  • Monthly Interest Accounts

The three important savings accounts are the first three listed above. Notice savings accounts offer variable interest rates, and withdrawals are available after a set date. Easy access savings accounts offer variable interest rates with free access to your money at any time.

You can get fixed-rate savings accounts that offer up to around 5% interest. However, you will not be able to gain access to your money for a fixed duration – the shorter the duration, the lower the interest rate. A 12-month fixed rate could typically offer an interest rate of 5%, whereas a five-year fixed rate might offer up to 5.16% interest. These interest rates are the best you’ll find.  Most savings accounts offer significantly. lower rates

The current inflation rate, as of the time of writing, stands at 4.0%. However, it still means that in real terms, money held in savings accounts is hardly growing; indeed, in many cases, it is losing value in real terms.

Moneyfarm does not offer savings accounts to clients. However, we have various investment accounts available to suit your risk tolerance and financial goals, so the next step concerning the ISA vs savings account debate is to take a look at the different kinds of ISA accounts.

Various types of ISA accounts

There are five different types of ISAs:

As already mentioned, the ISA allowance is £20,000 per annum. This is the total amount you can invest in any one tax year across all ISAs. It is split between them. You can invest the whole £20,000 into a Cash, an Innovative Finance, or a Stocks and Shares ISA, but you can only invest £9,000 per annum into a Junior ISA and £4,000 per annum into a Lifetime ISA.

When considering whether to invest in any type of ISA savings account, it’s important to ask yourself, “Are ISAs worth it? This question ultimately depends on your financial circumstances, investment goals, attitude to risk and time horizon. For example, if you are saving for a deposit on a house, you might decide on a Lifetime ISA (LISA) because the government will give you a 25% bonus worth up to £1,000 a year.

However, we are not currently offering a LISA due to the fact that the rules are complex, and you need to understand the small print to ensure you don’t lose out.

Which is the best ISA? It all depends on your financial goals and how you view risk. For example, if you compare the stocks and shares ISA vs cash ISA, the stocks and shares ISA will earn better returns, but it is probably riskier.

The choice between an ISA vs savings account is dependent on several factors. We have highlighted the differences between the two below.

The drawbacks associated with LISAs

The reason that many people opt for Lifetime ISAs is the fact that they are designed to help you purchase your first property, and the UK government tops up your contributions by 25% toward that goal. Your fund not only benefits from these government contributions, but the total investment also earns compound tax-free interest. Bearing in mind that even high-risk ISAs typically don’t return more than about 18%, it’s a good deal in anyone’s terms.

But there are drawbacks. They include:

  • You can only open a LISA if you’re aged between 18 and 39.
  • The government bonus ceases when you reach 50 years of age.
  • You can only use LISA funds to buy your first property, providing it costs no more than £450,000.
  • If you do not use your LISA to buy a property and withdraw funds before you reach 60 years of age, you will be charged 25% of the withdrawal amount.

If you are working on an ISA vs savings account comparison for buying your first property, the LISA easily comes out on top. But, given the drawbacks discussed above, consider opening one of the other types of ISA, such as the Stocks and Shares variant.

What is the difference between ISAs and savings accounts?

Before you can make a decision as to which one will suit you best, you first need to compare the difference between ISAs and savings accounts because there are disadvantages and advantages of ISA accounts over savings accounts and vice versa. There are several key differences between an ISA vs savings account.

Tax: An ISA is a tax-free wrapper, so any interest earned is completely tax free. However, for a savings account, any interest earned above the personal savings allowance will be taxed. The personal savings allowance (PSA) for a basic rate taxpayer is £1,000, and £500 for a higher rate taxpayer. Additional rate taxpayers don’t have a PSA.

Deposit: The annual allowance for an ISA account is £20,000, which is the maximum deposit limit for an ISA each tax year. A regular savings account has no deposit restrictions; there is no limit or frequency requirement.

Account limit: At present, an individual can only open one type of ISA account each tax year, while there is no limit on how many savings accounts can be opened each tax year. From April 2024, you’ll be able to contribute to multiple ISAs of the same type.

Withdrawal: An individual savings account gives you access to your money when needed, but fund withdrawals may affect your ISA allowance if you don’t have a flexible ISA savings account. Access to funds in a savings account depends on the type of account, and some accounts have a withdrawal limit or a set number of withdrawals.

Minimum deposit: The minimum amount to open an ISA or savings account is dependent on the account providers.

Investment duration: ISAs are suitable for long-term investments and huge savings, and the return on investment depends on the interest rates (Cash ISA) or performance of investments held in an ISA (Stocks and Shares ISA). Savings accounts are ideal for short-term savings, and returns are also determined by the interest rates received, but remember, taxes can impact the interest earned in a savings account.

Risk: ISAs have some level of risk involved. Some risks include inflation risk, market risk, and capital risk. Cash ISAs have no capital or market risk; however, they are vulnerable to inflation risk. In the ISA vs savings account debate, the latter can only be affected by insolvency and inflation risk. So investors need to ask themselves, “Is an ISA worth it with the risks involved?” before investing.

It should also be pointed out that innovative finance ISAs are potentially riskier when comparing ISA accounts.

ISA or savings account – which is best for Me?

The ISA vs savings account comparison listed previously will aid your decision regarding which savings account is suitable for you. The interest rates that Cash ISAs tend to make are pretty much the same as the interest you would get in an ordinary savings account. So, it’s the best savings account for some people, as it’s a level choice, particularly if they’re only saving in the short term.

A factor to consider when asking, “Are ISAs worth it?” is your tax situation. Some savers no longer have to save into an ISA to earn tax-free interest because of the introduction of the personal savings allowance (PSA). For instance, basic-rate taxpayers may not have to save into an ISA to earn tax-free interest if they don’t exceed their personal savings allowance. In this instance, a savings account may be ideal. However, the advantages of ISA over a savings account occur if you expect to earn more in the future or are a high-rate taxpayer. As a high earner, ISAs may be a valuable tool for reducing your tax bill.

But if you are considering the ISA vs savings account question, when it comes to long-term savings, where the interest is likely to rise above £1,000 per annum after several years, you will start paying tax on anything above that threshold with an ordinary savings account. But with an ISA savings account, the interest carries on being tax-free. So, in this case, the answer to whether an ISA or savings account is more beneficial has to be the ISA.

When to use a savings account

If you are considering whether a Cash ISA or Savings Account is best for you, you need to take several things into account.

It’s generally best to put your money into a savings account for short-term goals like paying unexpected or unexpectedly large bills.  It’s particularly valid in the midst of a cost-of-living crisis. When these savings are kept short term, the damage that inflation can do to the value of the money is minimised, but if kept in this savings vehicle long term, the real value of your savings will significantly devalue.

But the big advantage of setting up an emergency fund savings account is that you can access your money without notice or delay.

What about the cash ISA vs savings account argument? While there is little difference between the two regarding the interest your money will earn, the savings account probably comes out on top regarding accessibility because you can pop out and withdraw money from your bank or local ATM at a moment’s notice. With a Cash ISA, it may take a day or two.

When to use an ISA account

Before embarking on saving or investing, it’s important to get your financial planning right, and this involves deciding on your short- and long-term financial goals. Having already discussed the question of ‘Is an ISA or savings account better for short-term savings’ we can conclude that the savings account is probably best for short-term savings.

The best ISA or savings account scenario

The best ISA savings account from the point of view of the interest it can earn is the Stocks and Shares or Investment ISA. They are one and the same thing.

You’ve read how poorly the savings account vs ISA performs concerning interest. A Stocks and Shares ISA offers much higher potential returns. Using figures published on Moneyfacts, between February 2021 and February 2022, investment ISAs showed a return of 6.92%, while the best-performing stocks and shares ISA sector had a return of 27.69%. Over the same period, Cash ISAs returned only 0.51%.

The Stocks and Shares ISA savings account – the risk factor

There is a saying that you have to speculate to accumulate, which comes into play when considering taking out a Stocks and Shares ISA. Martin Lewis best ISA rates for over 60s are linked to this type of ISA above all others for those who are not risk averse. Yes, financial markets have a reputation for being volatile, which is clearly in many people’s minds following the COVID-19 crisis. But it shouldn’t be viewed in isolation.

Historically, financial markets have always recovered, and indeed, that has proved to be the case yet again. Nevertheless, it can take them several years to do so, and this is one of the main reasons that when contemplating opening a Stocks and Shares ISA – you need to invest for the long term.

However, historically, financial markets have always recovered, and indeed, that has proved to be the case yet again. Nevertheless, it can take them several years to do so, and this is one of the main reasons that when contemplating opening a Stocks and Shares ISA – you need to invest for the long term.

Putting your savings into an Investment ISA (Stocks and Shares ISA) can produce spectacular results over the long term. It is compound interest coming into play. Basically, the interest your fund makes in one year increases the fund’s value, and it is the new total value against which the interest accrues.

However, when comparing the ISA vs. savings account option, it has to be understood that with stocks and shares ISAs, your fund can shrink or grow, which is the risk.

Introducing Liquidity+

Moneyfarm presents Liquidity+, a fresh investment approach promising a gross annualised yield currently surpassing 5.2%. It boasts a low-risk profile and transparent, competitive pricing. Beyond being a low-risk asset made up of instruments like bonds, CDs, and commercial paper, it’s a tactical method for short-term savings.

By leveraging increased yields from recent rate increments, it offers a tailored market entry pace. A fund yielding over 5.3% annually minimises risk, amplifying liquidity’s worth through a meticulously designed solution. Given the attractive interest rate of Liquidity+, it’s an ideal alternative for those who have exhausted their ISA allowances or are looking for savings options that outperform traditional ISAs.

Tailored for a 2-year or shorter duration, Liquidity+ promises adaptability, allowing fund exits or transfers into other Moneyfarm portfolios at any time. Our Asset Allocation experts handpick top money market funds for Liquidity+ while overseeing performance and risk, making essential tweaks. Guidance is on hand to pinpoint Liquidity+’s place in your portfolio, aligning it with your financial aspirations and risk tolerance.

Ongoing performance tracking guarantees goal achievement in the most effective manner. With a straightforward 0.3% management fee (inclusive of VAT) + 0.1% for underlying funds, Liquidity+ not only offers transparent and competitive rates but also ensures each investment receives the highest attention and precision.

Final thoughts on the Stocks and Shares ISA v savings account

When considering the ISA vs savings account question, it all boils down to two things. Are you looking for a long-term investment? And how risk-averse are you? The two are inextricably linked.

The longer you can leave your investment where it is, the better. It could drastically reduce the risk of being forced to take out your savings at a time when the stocks and shares market has dropped.

It also depends on how you build your stocks and shares portfolio. There are high, medium and low-risk options. Which portfolio to choose from depends on your attitude to risk and your knowledge of the markets. You can again benefit from the help of a professional financial adviser or take advantage of the Robo-advisor platforms that are now around. The choice is yours.

Is an ISA better than a savings account?

The answer to the question of “Is an ISA better than a savings account” depends on your personal circumstances – your financial goals and your investor profile, including your attitude towards risk. Short-term savings, where immediate access is key (like for an emergency fund, for example), are probably better served by being kept in a savings account or a cash ISA.

Long-term savings, like investments for your retirement, will be better served in SIPPs or ISAs, where the action of accrued interest can make an enormous difference to the eventual sum in the account when you decide to retire.

While a SIPP is a form of pension and you can only access 25% of the funds tax-free when you are aged 55 or over (any more will be subject to income tax), all ISAs are more tax efficient because when withdrawing money from your ISA,  no matter the amount, you don’t normally have to pay any income tax.

Why use an ISA over a savings account?

If you are one of the higher-rate taxpayers in the UK and you can afford to maximise your PSA every year, if the interest on your investment exceeds £1,000 per annum, you will have to pay tax on the excess, but this doesn’t apply to an ISA.

Provided you are okay with accepting a degree of risk (with stocks and shares ISAs, you can select the risk level), and you are happy to invest long term, your investment will attract a significantly higher interest rate in most ISAs than it would in a savings account, except when it comes to the cash ISA vs stocks and shares ISA debate.

If you have several ISAs, you might find that some are performing better than others, or you might find it difficult to keep up to date with them all from a management point of view. If so, you can transfer your ISA accounts with an ISA transfer.

What is the disadvantage of a Cash ISA?

Lifetime ISAs and stocks and shares ISAs receive decidedly higher returns than savings accounts in the stocks and shares ISA vs savings account comparison because they offer significantly higher interest rates. But when it comes to the debate between a Cash ISA vs savings account, savers should opt for the savings account. This is because some of the best savings accounts often offer better interest rates than Cash ISAs, and with immediate access to your savings, putting your money into a savings account could be your best option.

It might be different if you are a higher-rate taxpayer, but since the introduction of the PSA in 2016, if you are a basic-rate taxpayer, you can save tax-free as long as the interest you earn doesn’t exceed the £1,000 per annum PSA threshold.

Should I move my Cash ISA to a savings account?

According to Martin Lewis, to breach the PSA threshold, you would have to save around £70,000 per annum, which is pretty unlikely if you’re a basic rate taxpayer. So, yes, in this savings vs ISA comparison, you should move a Cash ISA to a savings account, provided you’ve done your homework and found an account with a better rate.

FAQ

Which is better, a savings account or ISA account?

Your ISA vs savings account option will depend on factors such as your investor profile, financial goals, age, etc. A savings account is ideal if you want to save small amounts of money for the short term and need easy access to cash. However, ISAs are better for long-term financial goals such as retirement or saving to buy a house.

What are the advantages of ISAs over a regular savings account?

ISAs are tax-free. No income or capital gains tax is imposed on returns in the ISA, while the returns on a savings account are liable to income tax. ISAs are flexible and offer many investment opportunities, making them earn better interest than a regular savings account. In addition, your spouse may be able to inherit your ISA tax-free.

What are the disadvantages of an ISA?

Tax-free contributions towards an ISA are limited. The ISA allowance for the 2023/2024 tax year is £20,000, and any unused annual allowance is not carried forward. Investments held in an ISA can lose value due to stock market volatility, and ISAs might not be suitable for short-term investments. Currently, you can only open one ISA per tax year, although from April 2024, you can pay into multiple ISAs of the same type.

Are ISAs worth it?

Whether ISAs are worth it depends on an individual’s specific circumstances and investment objectives.

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*Capital at risk. Tax treatment depends on your individual circumstances and may be subject to change in the future.