How does an ISA work?

Written by
Bence András R.
Fact checked by
Gyula L.
Updated
Mar 2023

Let’s say you decided to go with an ISA savings account, because you are a UK resident and have some excess cash to deal with. But what is the next step? After getting familiar with ISA types, let’s go over how they work, and what would happen if you decided on one of the ISA account types as your source of investments.

THE ESSENCE:

  • You open an ISA account at either at a bank, or broker. After making a deposit, based on the account type, you will receive tax-free interest or capital gains on your investments. 

  • Depending on the conditions, you will receive your deposit back after a certain period of time

  • Most of the time you can withdraw your deposit at any time, except with a fixed-rate cash ISA or a LIfetime ISA

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How do ISA accounts work?

To understand how an ISA works, it’s best to separate them by account type and go through the details individually.

Cash ISA

  • This is the simplest way to invest in an ISA.

  • What happens is, you put your cash in a savings account.

  • The cash ISA account allows you to earn a variable or fixed interest rate based on the amount of money invested. 

  • Choosing a fixed-rate plan may provide you with better rates in exchange for leaving your money in your account for a certain period of time.

  • Choosing a variable rate plan may have lower interest rates, but you can withdraw your funds at any time.

 

Stocks and shares ISA

  • The cash amount you plan on investing is used as a contribution to the market. So they are not held in cash, but rather in a stock, ETF, bond or a combination of these products.

  • Your cash can also be held in a mutual fund. A mutual fund is when multiple investors pool their cash into one and is used to invest in stocks, bonds, ETFs or other products.

  • Gains on a stocks and shares ISA may potentially outgrow a cash ISA, however, investments can also drop in value, meaning you can get less back than you initially invested.

  • A stocks and shares ISA also requires you to leave your contributions untouched for a few years.

 

We compared the brokers that offer stocks and shares ISAs, so you don't have to, check out our recommendations!

 

Lifetime ISA

  • You can only start a Lifetime ISA account if you are aged between 18-39.

  • A Lifetime ISA can be used to buy your first home or save for later life

  • If you are eligible, this account allows you to save up to £4,000 a year.

  • The first payment can be made from this ISA before you are 40.

  • Every year, the government will add 25% to your yearly allowance, meaning £1,000 per year.

  • You can use your savings to purchase a home, but only if certain conditions are met. For example, you can withdraw and use your funds if you find a home that is under £450,000.

  • You can also use your savings for your retirement. You can only withdraw your LISA retirement savings once you are 60. If you take out your money earlier than 60, you’ll be charged a withdrawal charge of 25% of the amount you withdraw.

 

Innovative Finance ISA

  • You put cash into an Innovative Finance ISA.

  • Individuals or businesses borrow this cash through a platform.

  • The individual/business pays interest, as this is basically a loan arrangement.

  • Interest rates may be higher, however, your investments can be at risk if the borrower defaults.

 

Let's recap how the different types of ISA work!

Types of ISAs
  Cash ISA Stocks&Shares ISA Innovative finance ISA Lifetime ISA
Assets you can hold Cash Various assets (stocks, ETFs, bonds, mutual funds, etc.) Alternative investments like peer-to-peer lending Cash and investments (stocks, ETFs, bonds, mutual funds, etc.)
Can you withdraw funds without penalty? Yes Yes Yes No*
Is it protected? Yes, up to £85k under FSCS Yes, up to £85k under FSCS No Yes, up to £85k under FSCS
Is there an age limit? No, unless you open a Junior ISA** No, unless you open under Junior ISA** No Yes, from age 18 to age 40

* 25% fee is charged, unless you turned 60 or you buy your first home with mortgage

**You can open a Junior ISA for children under 18

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Further reading

Author of this article

Bence András Rózsa
Bence András Rózsa

Bence is a former broker analyst for BrokerChooser. Having an MSc in international economy and finance, he focused on equities, cryptos and newcomer financial services. He also gained years of experience within the brokerage industry, specializing in stock and CFD/forex brokers, crypto providers and robo-advisors.

Everything you find on BrokerChooser is based on reliable data and unbiased information. We combine our 10+ years finance experience with readers feedback. Read more about our methodology.

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