What is an ISA?

Written by
Katie Clarke
Time to read
4 minutes, 48 seconds

 

When you hear people talking finance, do you find yourself thinking ‘what is an ISA?’.

Let’s start with the basics, what is an ISA? – An ISA is an Individual Savings Account. It is different from a normal savings account because an ISA is a tax-free account. Every tax year, you have an ISA allowance that allows you to save or invest money up to a certain amount without paying income tax or capital gains tax on your returns.

The ISA allowance for the current 2023/24 tax year is £20,000, and the tax year runs from the 6th April to the 5th April the following year. Whether you’re able to use up your full allowance, or want to invest a regular amount, an ISA can help you to grow your money and shelter it from tax.

There is no tax on withdrawals but you should check with your provider as some, unlike True Potential, might charge an exit fee or pay a lower interest rate if you withdraw early.

You need to consider the different types available to you. Here are the four main types of ISA:

You can spread your annual allowance out yearly across the different types of ISAs if needed.

Now you know what an ISA is in general, we can dive into a comparison between the two most common – Cash ISAs and Stocks & Shares ISAs. The former is essentially a tax-free savings account while the latter is an investment account.

Firstly, Cash ISAs are dependent on interest rates in terms of growth, and Stocks & Shares ISAs are dependent on the performance of the funds they are invested in.

When deciding between a Cash ISA or a Stocks & Shares ISA, remember to check the current interest rates. Cash ISAs are currently the most common type of ISA in the UK, however the interest rates for these are often low.

If the inflation rate is higher than your interest rate, your money could slowly be losing its buying power if it’s left in a Cash ISA. This is because the prices of goods/services are rising, but the value of your money isn’t keeping pace with it.

If Inflation is increasing more than your money grows, the cash in your Cash ISA buys less over time. For example, if inflation is at 2% and your Cash ISA pays 1% interest, you’re falling behind.

A Stocks & Shares ISA doesn’t rely on interest rates to earn growth, the opportunity for growth comes from the performance of the funds they are invested in. Some people may find this concept intimidating, as you have to keep in mind that with investing, your capital is at risk and the value of your investment may fluctuate. Interestingly, if you leave your money in a Cash ISA, although the risk seems minimal, you still could lose value due to inflation. This is why people look to the investment market for growth, as if you invest in a Stocks and Shares ISA for the long term and in a diversified portfolio, you can smooth out market volatility, which reduces the risk of your investments losing value.

The type of ISA you choose should ultimately depend on your personal financial goal. If you have a shorter-term goal (less than five years away) that you want to save up for, a holiday for example, then a Cash ISA may be the most appropriate choice as less risk is involved. Your money may not achieve additional growth, but it is a steadier route to saving. On the other hand, for goals that are long term, i.e. your retirement, children’s education or a house deposit, you could consider a Stocks & Shares ISA. More time in the market will allow your money to grow and recover from any falls or volatility

Just like a Cash ISA, you can withdraw from a Stocks & Shares ISA at any time. Most people tend to leave their money invested for as long as possible; this is because your investment could benefit from compound growth, which is where you get growth not just on your original investment, but also growth on the growth, but of course it isn’t guaranteed.

Hopefully you now understand why an ISA is an important financial tool that can help you do more with your money. To summarise:

  1. You can save and invest up to £20,000 in the 2023/24 tax year in your ISAs. You won’t pay tax on interest on cash, or on income or capital gains from investments.
  2. A Cash ISA is linked to interest rates, which could be below inflation with cash losing its buying power, whereas a Stocks & Shares ISA is linked to the performance of the investment. With Stocks & Shares ISAs, your capital is at risk and the value of your investment may fluctuate.
  3. You can withdraw your money at any time without any tax penalties, but the longer you are invested for, the more opportunity you’ll have to grow your money.

 

True Potential Wealth Management offers restricted financial advice. Our service is specifically designed for clients wishing to access their financial affairs online. With investing your capital is at risk. Investments can fluctuate in value and you could get back less than you invest. Tax rules can change at any time. Please be aware that this communication should not be considered as financial advice.

True Potential Wealth Management LLP is authorised and regulated by the Financial Conduct Authority.  FNR Number 529810.  Registered Head Office: Newburn House, Gateway West, Newburn Riverside, Newcastle upon Tyne, NE15 8NX. True Potential Wealth Management is a Limited Liability Partnership. OC356611.

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