🔔 Which ISA is nicer?

Individual Savings Accounts (ISAs) were introduced in April 1999 – replacing the Personal Equity Plan (PEP) and the Tax-Exempt Special Savings Account (TESSAs). At that time, the total annual allowance was £7,000 – of which up to £3,000 could be deposited into a cash ISA.

There have been several changes to the ISA allowance over the years, but it is only since July 2014 that the rules changed to allow the full allowance to be put into a cash ISA – at that point the allowance was £15,000.

The allowance has increased a little more since 2015, however the ISA allowance will remain at £20,000 from the new tax year, the eighth year at this level, which is disappointing, especially since it is arguably more important than ever to make the most of it.

With interest rates rising, many people are turning to cash ISAs in order to avoid paying tax on the interest earned, but there are other options too – so which should you choose?

There are four main types of adult ISA; cash ISA, stocks and shares ISA, lifetime ISA and innovative finance ISA - and you can either put your whole allowance into one type, or split it between them – as long as you don’t go over the total allowance. And although at the moment you can only contribute to one of each type per tax year, this restriction is being removed from the 6th April this year.

Cash ISAs

Cash ISAs are tax-free savings accounts – and like standard savings accounts, they come in all shapes and sizes – from  easy access, to notice and fixed term. As with standard savings accounts, the rates of interest on offer vary dramatically, so you need to keep an eye on the best rates available, both when you open your ISA, but also going forward.  And, especially with the variable rate ISAs, switch if the rate you are earning is no longer competitive.

Stocks and Shares ISAs

These provide a tax efficient wrapper to hold various types of investments, including shares, unit trusts, exchange traded funds (ETFs), corporate and government bonds. Income or asset growth with a stocks and shares ISA is free of both income and capital gains tax.

Jasmine Abraham, Independent Financial Planner at The Private Office adds “Whilst cash has performed well over the last couple of years, over the longer term the real value of your cash is likely to be eroded. Therefore, many may still look to stocks and shares ISAs as a way to achieve a return above inflation over the longer term as a way of protecting the value of their money”. 

“Diversification is key and sticking with just one asset is generally not a sensible long-term strategy. But it is important that you are comfortable with the bumps in the road associated with investing, which can be a shock to those used to savings accounts where the capital value does not fluctuate.”

Lifetime ISA (LISA)

Introduced in April 2017, the lifetime ISA (LISA) offers a much-needed boost for younger savers who are looking to save for a deposit on their first home or for retirement.

The LISA is a great option for anyone aged between 18 and 39, as you can deposit up to £4,000 a year and you’ll receive a government bonus of 25% on each deposit, which you can keep as long as you use the proceeds to buy your first house – or until you are aged at least 60 as a retirement pot. And the proceeds are tax free.

If you deposited a lump sum of £4,000 a year for five years, you would receive £1,000 bonus in the month following the deposit – and after five years, assuming an interest rate of 4.25% which is currently the best cash LISA rate available, you would have around £28,374 – made up of;

-  £20,000 personal deposit

-  £5,000 government bonus

-  £3,374 tax-free interest

There are plenty of rules to watch out for with a LISA too, so it’s important to know the restrictions as well as the benefits before committing the money. For example, there is a penalty for withdrawing the cash before the age of 60 for anything other than a first home purchase and the LISA must be held for a minimum of 12 months to avoid the charge.

The penalty, if it were to apply, is 25% of the amount withdrawn. Although this would seem to simply be a return of the government bonus, it actually works out that there is an extra penalty of roughly 6.25% that will apply. So, as well as losing the bonus, some of the money deposited would also be taken. However, help may be on the way as it’s been suggested that the Chancellor, Jeremy Hunt, may announce a cut to this penalty, to 20%, which would mean that savers would at least get back what they put in.

A LISA can be held in cash or in stocks & shares. The most appropriate choice would depend on timelines, with shorter term funds usually better kept as cash and invested stocks and shares ISAs being more suitable for long-term money (5+ years). Any interest or growth would be tax-free within that lifetime ISA wrapper.

Innovative Finance ISA

Launched in April 2016, this ISA accepts deposits in peer-to peer (P2P) lending, so that any interest or capital gains will be free of tax. Put simply, peer-to-peer lending means you can lend to individuals or businesses via a P2P platform, without going to a bank.

Whilst P2P lending looks similar of standard cash savings, there is a possibility that your loans may not be paid back, so there is a greater risk. And there is no Financial Services Compensation Scheme (FSCS) protection should something go wrong.

Some P2P platforms have contingency funds to protect investors from loan defaults, but it is not guaranteed.

Finally, although not available to adults, there is another ISA allowance for children under the age of 18. The Junior ISA (JISA)

Junior ISA

These were introduced in November 2011 and replaced the Child Trust Fund.

You can open a JISA for your child from birth and the current annual allowance is £9,000. Whilst it must be opened by a parent or guardian, anyone can then add to the account, as long as the annual allowance is not exceeded.

If you and your family and friends were able to deposit £9,000 a year into a JISA for your child and it were to grow by 5% a year for the next 18 years, they could receive a gift of over £265,000 on their 18th birthday! Now that’s a gift worth having.

Of course it’s important to understand that they have unfettered access to that money when they turn 18 – however, they could also transfer it to an adult ISA at that point, to continue earning tax free income and/or growth.

You can choose between stocks and shares or cash, or a combination of the two. Currently the top ISA rate is 4.95% with Coventry Building Society. Keep an eye on the JISA Best Buy table for up to date rates.

Unless the Chancellor has an ISA rabbit ready to pull out of his hat, the ISA allowance will remain at £20,000 in the next tax year. But if you’ve yet to use your allowance this year, you could squirrel away as much as £40,000 from the taxman over the next few weeks. That’s got to be something to mark as urgent on your to-do list. Keep an eye on our  easy access, notice and fixed rate ISA tables for the very best rates available.