An in-depth guide to ISAs

Written by
Fact checked by
Adam N.
Apr 2024

The only way you can ensure that you will have enough to cover your needs in your old age, give your children a head start in life or buy your first house is to start saving while you are still young. Unfortunately, inertia is a powerful force, and switching from not saving to saving can be overwhelming for most. Making up your mind to start saving is an essential first step, but the road to having a sensible savings strategy can be long and winding. The key challenge is to find the solution that best suits your needs and financial profile. Even though savings possibilities are vast and confusing, some solutions trump others. Most countries have a tax-advantaged savings program, and we investigated what the UK had to offer its residents in that category. Individual Savings Accounts (ISAs) have wide appeal in the UK as they offer a sweet proposition—a chance to grow your money free from taxes. If you are a UK resident and saving for your financial goals, not holding an ISA is essentially leaving  money on the table for the taxman. Below is an in-depth guide on ISAs and their most essential features.

What is an ISA

Most people think that ISAs are complicated given that they come in several shapes and sizes but in truth they are rather simple. In a nutshell, an ISA is a tax-free savings account that lets you save or invest money up to a certain amount without paying tax on your returns. You don’t even have to declare your ISA holdings in your annual tax return. Normally, the return on your investments (i.e. your gain when selling shares at a higher price than what you paid to buy them) would be subject to a Capital Gain Tax (GTC) of 10, 18, 20 or 28%, depending on what tax rate you pay on your income. Seeing how you don’t have to pay any taxes on your ISA holdings, the savings due to using an ISA can be rather substantial.

There is a limit set by the government on how much you can put into the tax-free wrapper each tax year, called an ISA allowance. The allowance for the 2021/2022 tax year running through April 5 is £20,000. The Junior ISA allowance (ideal for giving your child aged under 18 a head-start in life) is £9,000, up from £4,128 a year earlier. 

Note that the limit applies to all the ISAs you hold or open, meaning that you can’t open multiple ISAs in a single tax year and benefit from the tax-free savings allowance in every one of them. Adversely, if you fail to use up your allowance in a given tax year, you will lose it forever as you are not allowed to roll it over to the following year. Given the use it or lose it nature of the ISA allowance, it’s best to max out the limit each year. 

You can put your money in different types of ISAs (cash ISA, stocks and shares ISA, innovative finance ISA, Lifetime ISA) or you can split the money between them. Bear in mind that you can only put £4,000 in the Lifetime ISA every year, which means you could put the remaining £16,000 into any of the other types. 

As an example, you can either use the maximum allowance for cash or investing or you can mix your portfolio by splitting the £20,000 between cash, stocks and shares, Lifetime or innovative finance ISAs. You get to choose! The only rule is that the combined amount you invest cannot exceed £20,000.

Many ISAs give users access to their funds at any time, making them perfect for storing tax-free money that might be required in an emergency. You can also take money out of your ISA and then put it back in the same tax year without losing the tax shelter advantages.

Main advantages of ISAs

  1. Money saved or invested within the ISA wrapper earns interest and benefits from tax-free status. You do not have to pay tax on any income you receive from ISA investments, including capital gains, dividends, interest and bonuses. You do not even need to tell the taxman about your ISA. In the long run, this can save you a significant amount of money and increase the returns on your investment.

  2. You can access the funds in an ISA almost any time you want (except Lifetime ISA) without having to pay a withdrawal or penalty fee. Note that some cash ISAs have a fixed term, meaning that you lock your money away for a set period in return for a better interest rate and you may have to pay a penalty if you break the term. With a Lifetime ISA, you won’t be able to take money out until you turn 60 without paying a penalty unless you withdraw it for specific reasons. 

Types of ISAs

ISAs come in different types to suit various needs. While all SAs enjoy a tax-free status, there are differences in the types of assets you can hold in each and the purpose of the savings. There are four main types of ISAs that adult UK residents can hold: 

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

Cash ISA

Except for the taxation aspect, a cash ISA is not that different from a traditional savings account. Depositing money in a cash ISA pays you interest and shields you from financial market volatility. Even though your money is safe in a cash ISA, its value may decline in real terms if the interest you receive is less than the rate of inflation. The interest on cash ISAs - in a best case scenario - tends to be a few percentage points higher than the Bank of England benchmark interest rate and typically moves in tandem with the BoE rate.

Some cash ISAs offer highly attractive initial ‘bonus’ rates, available for a set period, before changing to a much lower rate. By switching between providers (provided you have the time and patience), you can maximize the return on your cash ISA. For instance, if you move to a new provider after the bonus period expires at your current one, you may be able to take advantage of the bonus period offered by the new provider. 

Some cash ISAs grant you instant access to your savings so that you can withdraw and deposit funds as often as you want under the annual ISA allowance limit. With a flexible ISA, you can take out funds from your account and keep your allowance if you put it back in the same tax year. 

Funds held in a cash ISA are protected up to £85,000 through the Financial Services Compensation Scheme (FSCS) if your account provider is covered by the scheme. Cash ISAs provided by all banks, building societies and major financial institutions are covered by the FSCS.

Stocks and shares ISA

The name is a misnomer, since this type of ISA allows you to invest in a lot of other assets in addition to stocks and shares. The options include collective investment funds, Exchange Traded Funds (ETFs), investment trusts, gilts and bonds. Less liquid investments such as shares listed on the small and medium-sized company exchanges can also be included in this type of ISA. As a general rule, stocks and shares ISAs (also known as investment ISAs) carry a much higher risk of losing your money than a cash ISA, however, the return on these investments can also be considerably higher. One way to mitigate your risk is to invest over the long-term as this helps smooth out the ups and downs of the market and gives your money time to benefit from the power of compounding.

As with a cash ISA, you can take your money out of an investment ISA whenever you want.

Innovative finance ISA

As the name suggests, this is an innovative type of investment that enables you to lend money to approved individuals and businesses tax free. Transactions are carried out via an online peer-to-peer lending platform in return for a fixed amount of interest over a set period. Since there is no bank involved in the loan, you can reap higher returns with this form of investment but the associated risks are also much bigger. Borrowers can default and fail to pay you back and you would be unable to make a claim for compensation because your money isn’t protected by the Financial Services Compensation Scheme. You can mitigate the risks by spreading your money across multiple loans. Either way, make sure you gauge your risk appetite properly before opting for an Innovative Finance ISA. 

Lifetime ISA

The Lifetime ISA, also known as LISA, is designed to help people save for their first home and/or retirement. The contribution limit is £4,000 a year but the state will add a 25% bonus on top. So if you save £1,000, the state will pitch in £250. The bonus, paid until you turn 50, is paid monthly and you'll receive interest on it too. The maximum bonus any person can get in their lifetime is £33,000 and to get that you'd have to open a Lifetime ISA on your 18th birthday and keep contributing the maximum £4,000 each year until you are 50. 

If you opt for a Lifetime ISA, you can hold cash or investments, or a combination of both - the choice is up to you.

If you want to purchase a house with money held in a LISA, you must be a first-time buyer and the price of the home you want to buy cannot exceed £450,000. You will also have to purchase your house with a mortgage.

The funds in your Lifetime ISA can only be withdrawn when you purchase your first home or once you turn 60. If you withdraw funds before or for any other reason, you’ll be charged 25% of the amount you withdraw.

How to open an ISA

There are few restrictions on who can open an ISA. If you meet the following basic requirements, you are eligible to hold one or more ISAs:

  • You must be a resident in the UK, or a Crown servant (i.e. diplomatic or overseas civil service) or their spouse or civil partner
  • You must be 16 or older for a cash ISA
  • You must be 18 or older for a stocks and shares ISA 
  • You must be 18 or over but under 40 for a Lifetime ISA 

The ISA account has to be in your name but you can set up a Junior ISA for children under 18.

Under current regulations, you can open an ISA with the following institutions: 

  • banks
  • building societies
  • credit unions
  • friendly societies
  • stock brokers
  • peer-to-peer lending services
  • crowdfunding companies
  • other financial institutions

You can open a new ISA with a different provider each tax year as there’s no rule that says you have to stay with the same provider.

You don't need thousands of pounds in the bank to open an ISA. Many cash ISAs can be opened with a starting amount of just £1. If you want to open a stocks and shares ISA, most funds will accept monthly contributions starting from either £25 or £50.

How to wihdraw money from an ISA

Generally speaking, you can take your money out from cash ISAs any time without losing any tax benefits. Nevertheless some restrictions and charges may still apply for making withdrawals. If you have an instant access cash ISA, you can withdraw money any time without restrictions. This is the best ISA vehicle for holding funds that you may need on short notice. If you choose a fixed-rate cash ISA (opened for a specific period, with an interest rate that depends on the length of your term), you will usually have to pay a penalty for any withdrawal before the end of the term. 

If you hold a flexible’ cash ISA, you can take out cash and provided that you replace the amount during the same tax year, the withdrawal will not reduce your current year’s allowance. As an example, if you deposit the full £20,000 in your ISA and then take out £5,000 to cover some unexpected costs, you can replace the £5,000 at a later date in the same tax year without breaching your allowance. Note that not all providers offer flexible ISAs, so check first before withdrawing cash.

Similarly, you can withdraw your money from an investment ISA at any time but the value of your investments may be lower if you sell your assets when the market is down. Investment ISAs can also be flexible and non-flexible, but most providers shy away from offering flexible investment ISAs. 

Withdrawals from Lifetime ISAs are governed by stricter withdrawal rules. You won’t be permitted to take money out of the account until you are 60 without paying a penalty unless it is put towards a deposit on a first property worth up to £450,000. You can also withdraw your money if you are terminally ill. In all other cases, the withdrawal penalty will be 25% of the amount you take out. 

Note that all Lifetime ISAs are non-flexible.

How to transfer an ISA

You can transfer your ISA from one provider to another at any time just as you can transfer your savings to a different type of ISA or to the same type of ISA. There are various reasons why you might want to make an ISA transfer. You might want to transfer to a provider that offers a wider range of funds or to reduce your investment costs. 

Contact the ISA provider you want to move to and have them fill out an ISA transfer form to move your account. 

Some of the most important restrictions that apply to transferring ISAs are as follows: 

  • If you transfer funds from a Lifetime ISA to a different ISA before the age of 60, you’ll have to pay a withdrawal fee of 25%

  • You can transfer cash from your Innovative finance ISA to another provider but you may not be able to transfer other investments (i.e. peer-to-peer loans) from it

  • Check with your provider for any restrictions/charges they may have on transferring ISAs.

FAQ - the bottomline on ISAs

Should I open an ISA? 

If you would like to save money and reduce your tax bill at the same time, opening an ISA is the best option. The biggest advantage of an ISA is that the returns you earn from putting money into an ISA are tax-free. For example, if you invest in a stocks and shares ISA, any profits you make will be free of Capital Gains Tax (CGT) and dividend tax, which would be payable if you invested outside an ISA. Another factor that increases the appeal of ISAs is that most are easy access accounts so you can make withdrawals whenever you need to. If you hold a flexible ISA, you can replace any cash you have withdrawn (up to the ISA limit) within the same tax year without breaching the annual contribution limit. Depending on your risk appetite and financial goals, you can choose between different types of ISAs. 


How much can I contribute to my ISA? 

In the 2021/2022 tax year, the ISA allowance is £20,000. You can decide whether you want to split this between stocks and shares ISAs, cash ISAs, innovative finance ISAs and Lifetime ISAs. Keep in mind that contributions to a Lifetime ISA are limited at £4,000 per year. The ISA allowance cannot be rolled over to next year - if you fail to use up your allowance for a given tax year, you will lose it forever.


When can I withdraw money from my ISA? 

You can take your money out of an ISA - except for Lifetime ISAs - at any time without having to pay a withdrawal or penalty fee. Nevertheless, the ability to withdraw from an ISA is dependent on the specific type of assets you choose. For example, if the account is tied to a particular term, withdrawing funds before the term is over may result in penalties. Although withdrawals from ISAs can be made at any time, the money cannot be replaced at a later date if it exceeds the overall contribution for any given year. If you hold a flexible ISA, you can withdraw money and then top up your account and keep the tax advantages, provided both are done in the same tax year.


Can I transfer my ISA? 

You can transfer your ISA from one provider to another at any time just as you can transfer your savings to a different type of ISA or to the same type of ISA. When moving your account from one provider to another, have the provider you want to move your account to fill in an ISA transfer form on your behalf. If you want to transfer funds you’ve invested in an ISA during the current year, you must transfer all of it. For money you invested in previous years, you can choose to transfer all or part of your savings.

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Edith Balázs
Author of this article
I bring 20+ years of experience as a correspondent having worked for Bloomberg, Dow Jones and The Wall Street Journal covering macroeconomics, stock, currency and fixed-income markets. I hold a Master's degree in American Studies and Journalism.
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