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Types of ISA: different types of ISA accounts UK


When setting up a savings account, trying to figure out what solution is right for you can be confusing. If you want to start saving in a more tax efficient way, ISAs are a great place to start. But what exactly are ISAs and how do they work? 

In general, ISAs, or Individual Savings Accounts, are untaxed personal savings accounts that have a legal maximum of how much money you are allowed to pay into them each year. There are many different types of ISA, so choosing the best ISAs for you can get tricky!

The main types of ISAs are

While you can set up as many different types of ISAs accounts as you like, there is a maximum amount of money that you are allowed to pay in each year. For the 2021-2022 tax year, you can pay up to £20,000 combined into any of the ISAs you have. 

Let’s take a look at how each of the ISAs differ from one another.

Types of ISA: different types of ISA accounts UK: Summary table

❓ What is an ISA?ISAs, or Individual Savings Accounts, are untaxed personal savings accounts that have a legal maximum of how much money you are allowed to pay into them each year.
🤔 What is a Personal Allowance?In the UK, the standard Personal Allowance is the amount of income that individuals do not pay tax on, equal to £12,570 annually.
🇬🇧 Who can open an ISA?Top open an ISA, you must be a resident in the UK and at least 18 years old (16 for a cash ISA) and under 40 for a Lifetime ISA

Cash ISAs

This type of ISA is most similar to a traditional savings account: you pay money into the account, and the money in that account earns interest at a predetermined rate and you don’t have to pay taxes on the interest that you accrue over time. This is generally considered the safer option, since the performance of these ISAs aren’t subject to swings in the market. However, they are susceptible to the risk of decreased value due to inflation, if the inflation rate outgrows the interest rate of the Cash ISA.

Stocks and shares ISAs

As opposed to steadily accruing interest over time, stocks and shares ISAs, sometimes called investment ISAs, invest the money that you pay into it in things like shares, bonds, and property. The capital gains that you make through these ISAs aren’t taxed, but their return depends on the performance of the stocks and shares in the market. So be aware that there is greater risk that you may not see a return on your investment compared to cash ISAs, but there is also a greater chance of making higher returns, especially in the long term if you reinvest any profits made from investments – after all, history favours the bold!

Innovative finance ISAs

What makes innovative finance ISAs so innovative is that the mechanism for generating returns differs completely from cash and stock and shares ISAs. In an innovative finance ISA,with the money that you pay into the account,  you act as the direct lender to approved individuals or businesses, earning untaxed returns through a fixed interest rate over a set period of time. Because of the more direct relationship between the lender and the borrower, without the bank as the middleman, provides for more advantageous conditions for both parties.

Of course, there is also a great deal of risk involved in innovative finance ISAs, since the borrower can default on repayments and the money you pay into the account isn’t protected by compensation from the Financial Services Compensation Scheme. Before choosing to set up an innovative finance ISA, make sure you speak with a financial advisor to make sure you understand the risks involved in this type of savings account.

Lifetime ISAs

Lifetime ISAs are something of a combination of cash ISAs and stock and share ISAs, but are aimed specifically at young adults looking to open an ISA with advantageous conditions – in fact, only people between the ages of 18 and 40 can open a lifetime ISA. This type of savings account is meant to help you along as you save for retirement or for putting down a deposit on your first home, and is particularly advantageous, since the government contributes an additional 25% to all investments made in this kind of ISA each month. This is what type of ISA a help to buy is. The maximum that you can pay into this kind of ISA is £1,000 per year, and any gains that you make through interest or capital gains in this account are untaxed.

While they are quite advantageous for those looking to boost the long-term return of their savings, only young adults can open them, and you can pay into the account until you are 50, and the funds can be withdrawn from the account only when you reach 60 or when you go to buy your first house. If you decide to withdraw your money from the account before you turn 60 or for purposes other than those specified in the terms of the account, you will be charged 25% of what you withdraw.

Junior ISA

As the name suggests, Junior ISAs are savings accounts developed for parents or legal guardians who are looking for a tax efficient way to start saving for children under the age of 16. Junior ISAs can be structured according to the Cash ISA scheme or that of the Stocks and Shares ISA, and just as with the other types of ISAs, there is a yearly allowance for how much you and your family are able to pay into the account. For the 2021 – 2022 tax year, the annual allowance is £9,000. 

Similarly to Lifetime ISAs, Junior ISAs also have limitations on who can open the account, and when the funds can be accessed – only the child’s parent or legal guardian may open the account for them (although other family members and friends can also pay into the account) and the funds may only be accessed by the child once they legally become an adult. Once they turn 18 JISA account holders can choose to withdraw the money or to transfer the ISA into any one of the other ISAs designed for adults. 

If you decide to open a JISA for your child, it’s important to explain to them how the account works, that the capital gains or interest potentially generated by the account is not taxed and thus it is in their own best financial interest to keep the money in an ISA until they really need to use it.

Who can open an ISA

The specific requirements to open an ISA depend on the type of account, though in general you must be a resident in the UK and at least 18 years old (16 for a cash ISA) and under 40 for a Lifetime ISA.

FAQ

How many ISAs can one person open?

You can open as many different types of ISAs as you want, but there is a maximum amount of money you can pay into them each year. For the 2021-2022 tax year, you can pay up to £20,000 combined into any of your ISAs.

What is the best type of ISA to open?

Stocks and shares ISAs are a good way to accrue wealth in a tax efficient manner over time, since the capital gains that you make through these ISAs aren’t taxed.

What is an innovative finance ISA?

In innovative finance ISAs, the money paid into the account is lent to approved individuals or businesses, earning untaxed returns through a fixed interest rate over a set period of time.