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Savings & Investments

What is an ISA?

Written by Connor Mullins on May 21st, 2024 Time to read: 7 minutes

What is an ISA?

If you ever ask yourself, “What is an ISA account?”, you’ve come to the right place. Let’s start with the basics.

ISA stands for Individual Savings Account. It is different from a normal savings account because an ISA offers potential tax-free growth. Every tax year, you’ll receive an ISA allowance*. This 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 2024/25  tax year is £20,000, and the tax year runs from 6th April to 5th April the following year. Whether you’re able to use up your full allowance, or you want to invest a regular amount, an ISA can potentially help you to grow your money and shelter it from tax. With investing, your capital is at risk.

Our ‘What is an ISA?’ UK guide provides essential information on this type of account. We’ll discuss the benefits of using ISAs and why you might want to consider opening one today.

What are the different types of ISA?

You need to assess the different types of ISA available and your financial circumstances. Here are the four main types:

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

What is an investment ISA?

If you’re new to investing, an investment ISA (or Stocks & Shares ISA) could be a good place to start. This kind of account is a ‘tax-efficient wrapper’ that can be used around investment products.

Normally when investing, you’re required to pay tax on any income or capital gains you earn from your investments. But with an accredited and regulated Stocks & Shares ISA, any additional money made from your investments isn’t taxed, provided you follow the rules of the account.

Cash ISAs vs. Stocks & Shares ISAs

Cash ISAs and Stocks & Shares ISAs are the two most common types of ISA. The former is essentially a tax-free savings account, while the latter is an investment account.

Cash ISAs

Cash ISAs are tax-free savings accounts and most can be opened with as little as £1. There are various Cash ISAs that offer different ways to access your money. These include:

  • Instant access: You can withdraw and deposit money as and when you need to.
  • Limited access: You can only withdraw your money a certain number of times. If you exceed your withdrawal limit, your interest rate will drop.
  • Fixed rate: You’ll lock away your money for a fixed term, removing the risk of a fluctuating interest rate.

Cash ISAs are dependent on interest rates*** in terms of growth. If the inflation*** rate is higher than your interest rate, your money could slowly lose its buying power if left in a Cash ISA. This is because when the prices of goods/services rise, the value of your money doesn’t keep pace with the price rise.

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.

Stocks & Shares ISAs

Stocks & Shares ISAs don’t rely on interest rates to earn growth. The potential opportunity for growth comes from the performance of the funds they are invested in. However, it’s important to remember that your capital is at risk*** and the value of your investment may fluctuate.

While the risk seems minimal with a Cash ISA, you still could lose value due to inflation. This is why people look to the investment market for growth. If you invest in a Stocks & Shares ISA for the long term and in a diversified portfolio**, you can potentially reduce the risk of your investments losing value. With investing, your capital is at risk.

How do I choose between a Cash ISA and a Stocks & Shares ISA?

The type of ISA you choose should depend on your financial goals. If you have a shorter-term goal (less than five years away) that you want to save for, such as a family holiday, then a Cash ISA may be the most appropriate choice as less risk is involved. While your money may not achieve huge growth in a Cash ISA, it does offer a potentially 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 can allow your money to grow and possibly recover from any falls or volatility.

Just like a Cash ISA, you can withdraw from a Stocks & Shares ISA at any time. While there is no tax on withdrawals* do check with your provider as some, unlike True Potential, might charge an exit fee or pay a lower interest rate if you withdraw early. Our ISA is a flexible ISA which means you are free to withdraw and replace money from your ISA, provided it is done within the same tax year, without affecting your annual ISA allowance.

People may choose to leave their money invested for as long as possible so that their investment can potentially benefit from compound growth, which is where you get growth not just on your original investment, but also growth on the growth. However, this isn’t guaranteed.

How many ISAs can I have?

Starting from the 2024/25 tax year, you can open more than one of the same type of ISA in the same tax year. However, it is your responsibility to ensure you don’t exceed the total £20,000 ISA allowance* each tax year.

You also aren’t limited in the number of ISAs you can have, subject to successfully meeting the eligibility criteria for each account.

If you’re looking to make the most of your tax-free allowance, opening multiple ISAs can add variety to your savings. Different types of ISA can help you achieve different financial goals, so research each one.

What is an ISA allowance?

An ISA allowance is a set amount of money you can put into your ISA each tax year, without having to pay any tax on the money your ISA makes.

The 2024/25 tax year ISA allowance is £20,000. You can choose to deposit this amount in full with a Cash ISA, Investment ISA, or Innovative Finance ISA. You can only pay a maximum of £4,000 into a Lifetime ISA* each tax year until you are 50. You must also make your first payment into your LISA before you’re 40.

You can also decide to split your ISA allowance and use it across the four different types of ISA. But don’t forget, you can only pay into one of each type of ISA within a tax year (e.g. one Cash, one Lifetime, one Stocks & Shares, one Innovative Finance) and you can’t pay in more than your annual ISA allowance overall.

How to choose the right ISA

Choosing the right ISA can be challenging, especially with so many options available. So, when deciding on the best account, focus on your unique financial needs and goals.

Identify your motivation for saving or investing. Ask yourself whether it is for something short term or long term. Will you want regular access to your cash or would you prefer to lock it away? How often will you be contributing? Will it be every month, every year or as a one-off? Regardless of what you’re working towards, there’s an ISA out there to help you.

If you need further support choosing the right ISA, download our free guide** to ensure your savings are working hard for your future.

Do more with your money with True Potential

Whether you’ve decided on the right ISA or you’re still weighing your options, we’re here to help.

If you’re interested in investing, our Stocks & Shares ISA could be the one for you. Designed to help you reach your financial goals, the money you invest has the opportunity to achieve long-term growth. Please note, though, that your capital is at risk and returns aren’t guaranteed.

To learn more about ISAs with True Potential, get in touch** with us today. Our friendly team will discuss your options and help you do more with your money.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. This material is not a personal recommendation or financial advice and the investments referred to may not be suitable for all investors.

You should ensure your contribution does not result in your total ISA contributions within the tax year exceeding £20,000. Tax rules can change at any time. ISA eligibility and tax rules apply. This blog is not personal recommendation or financial advice.

 

Sources

*Data sourced from gov.uk and accessed on 13/05/24

** Data sourced from True Potential and accessed on 13/05/24

*** Other

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