Intro
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
How does an ISA work?
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
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This is the simplest way to invest in an ISA.
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What happens is, you put your cash in a savings account.
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The cash ISA account allows you to earn a variable or fixed interest rate based on the amount of money invested.
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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.
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Choosing a variable rate plan may have lower interest rates, but you can withdraw your funds at any time.
Stocks and shares ISA
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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.
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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.
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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.
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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
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You can only start a Lifetime ISA account if you are aged between 18-39.
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A Lifetime ISA can be used to buy your first home or save for later life
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If you are eligible, this account allows you to save up to £4,000 a year.
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The first payment can be made from this ISA before you are 40.
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Every year, the government will add 25% to your yearly allowance, meaning £1,000 per year.
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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.
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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
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You put cash into an Innovative Finance ISA.
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Individuals or businesses borrow this cash through a platform.
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The individual/business pays interest, as this is basically a loan arrangement.
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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!
| 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
Further reading
- Everything you wanted to know about ISAs
- What is an ISA allowance?
- What is an ISA: an in-depth guide to tax-advantaged savings for UK residents
- What is an ISA: a guide to tax-free savings in the UK
- How much can you put in an ISA?
- How many ISAs can I have?
- What is a stocks and shares ISA?
- What is a Lifetime ISA and how best to use it?
- How to open a Lifetime ISA
- What is a cash ISA?
- What is a Junior ISA?
- What is a flexible ISA?
- What is an Innovative Finance ISA?
- How to transfer your ISA?
- Which is the better investment: pension or ISA?
- Is ISA only for UK citizens?
- What is the safest ISA?
- What happens to my ISA if I move abroad?
- Does an ISA beat inflation?
- Interest on cash ISA: much do they pay?
- IBKR offers global access with local benefits for ISA holders
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