101 Guide to ISAs and How to Make the Most of Them

Like many things in the world of personal finance, the ‘ISA deadline’ doesn’t exactly conjure up exciting visions of wealth, financial freedom and ‘living your best life’. Nonetheless, it’s a pretty important event in the financial world, and one that you probably should pay attention to. So, on that note, let me introduce your definitive guide to the topic….

Welcome to “A 101 guide to ISAs and how to make the most of them”

What actually is an ISA?

Ok, so an ISA, or Individual Savings Account, is a ‘tax wrapper’. This is because it effectively ‘wraps up’ your money and protects any returns or interest earned on your money, from being taxed. Alongside your pension (see here for the infamous hot girl retirement guide) it’s one of the most tax-efficient ways to invest. You can either save or invest in an ISA, but we’ll get onto that in a second.

Sorry, I need to worry about tax?!

We all know the saying about death and taxes, right? Well, it’s true. Like it or not, tax is one of those inevitable parts of life. In most scenarios where you make money, either through work, or via an investment, the government is usually going to get their hands on some of it.

One of the benefits of putting money into an ISA is that it’s sheltered from both Income Tax and Capital Gains Tax. This means that any interest you earn on a cash ISA or returns on investments in a stocks and shares ISA is not subject to income or capital gains tax. You can contribute up to the annual allowance of £20,000 in the 2023/24 tax year. FYI: If you have investments outside of a stocks and shares ISA, you also have a £500 tax-free Dividend allowance on top of your ISA allowance (2024/25).

How much can you save or invest in an ISA?

You can contribute up to the maximum ISA allowance (currently £20,000) and any growth, returns or interest you earn are tax-free.

What types are there?

So the types of ISA you’ve most likely heard about are cash ISAs and stocks and shares ISAs, but there are more. Let’s take a look…

🐷 Cash ISA: This is an ISA that allows you to save money in a tax-free savings account. You earn interest on your savings, and you can usually withdraw your money at any time without penalty. However, some cash ISAs will offer you a better rate of interest if you’re willing to put your money away for a set period of time, with these there can be a penalty for withdrawing your money early.

📈 Stocks and shares ISA: This is an ISA that allows you to invest your money in stocks and shares, either directly or through funds. Any income or capital gains you earn are tax-free.

💡Innovative Finance ISA: This is an ISA that allows you to invest in peer-to-peer lending, crowdfunding, and other alternative finance options. Any income or capital gains you earn are tax-free.

🏠 Lifetime ISA: This is a type of ISA that allows you to save or invest up to £4,000 per year until you turn 50, and the government will add a 25% bonus to your contributions. You can use the money to buy your first home worth up to £450,000, or save for retirement, and there’s a government penalty if you need to withdraw the money for another reason. You must be 18 or over but under 40 to open a Lifetime ISA. There are also two types of Lifetime ISA: The stocks and shares Lifetime ISA and the cash Lifetime ISA.

🧒 Junior ISA: This is an ISA that allows parents to save money tax-free for their children. A parent of guardian must open the Junior ISA, but once it’s open anyone can contribute. The money in the Junior ISA belongs to the child and cannot be accessed until they turn 18. Any income or capital gains earned are tax-free. A Junior ISA does not count towards a parent or guardian’s £20,000 allowance, kids have their own £9,000 allowance! There are also two types of Junior ISA: The stocks and shares Junior ISA and the cash Junior ISA.

🏡 Help to Buy ISA: (NO LONGER AVAILABLE) This is a type of ISA that was available to open until November 2019, which allowed first-time buyers to save money tax-free towards a deposit on their first home. The government added a 25% bonus to the savings, up to a maximum of £3,000. Its nearest equivalent is the Lifetime ISA.

Sounds good, so I should open one?

This depends on your financial situation. If you’re looking at a stocks and shares ISA, then contributing to one makes you an investor. Generally speaking, you want to make sure you’ve got a solid financial foundation before you consider investing. This usually means…

• Having an emergency fund to get you through any difficult periods or situations
• Not having any expensive debt (e.g. credit card debt or loans)
• A medium to long-term mindset. This means that you’re comfortable not accessing your invested money for 3-5 years or more. This gives you a much better chance of actually making money.

How do I choose between a cash ISA and a stocks and shares ISA? Is that less risky?

Stocks and shares ISAs, over the longer term, have the potential to deliver a higher return than cash ISAs. However, with the potential for reward comes risk. As with any investment, while it may go up, there’s always a risk that the value of your investment could go down. This means you could get back less than the amount you originally invested. This is something you need to be comfortable with as an investor.

Cash ISAs on the other hand are generally less risky but you don’t have the same potential to grow your money.

The good news is, there are ways to manage your risk. Investing platforms such as Nutmeg allow you to decide on how much risk you want to take. There’s also nothing to stop you from opening up both a Cash ISA and a Stocks and Shares ISA.

For more on how to choose between saving and investing, take a look at this post on Instagram:

How many ISAs can I have?

The short answer is as many as you like. You can have as many Stocks and Shares ISAs, cash ISAs, and Innovative Finance ISAs as you want. However, you can only open or contribute to one of each of these types in a single tax year. When it comes to the Lifetime ISA, you can only contribute up to £4,000 into one each tax year.

So how much should I contribute?

This is a personal question and it’s important you think about your individual circumstances. Remember, if you’re looking to invest, you need to be comfortable with the idea of locking away your money for a good few years. If you’re considering a Cash ISA then you’ll want to think about the kind of access you need and compare the rates available. Some people also prefer to invest using something called a ‘drip feed’ strategy, which means contributing small amounts to their ISA throughout the year. This is opposed to a ‘lump sum’ approach where you drop it all in one go.  

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A quick note about risk...when you invest, your capital is at risk. This means you may get back less than you put in. It's why investing for the long term is so important (3+ years), this gives you time to ride out bumps in the market. Also...Tax treatments depend on your individual circumstances and may change in the future.

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