What is an ISA?
An ISA is an Individual Savings Account. It’s a special type of account that gives you the opportunity to save or invest a certain amount of money every year, without having to pay tax on any growth in your investments or savings.
Here’s how it works. Each tax year (6th April to 5th April), the government gives everyone in the UK aged 16 and over a tax-free allowance that you can put into ISAs. This amount is known as your ISA allowance. For the 2023/24 tax year the ISA allowance is £20,000. If you don’t use your whole allowance in a tax year it doesn’t roll over to the next year.
Understanding ISAs isn’t as complicated as you might think. However, there are many different types of ISA available, including cash ISAs, stocks and shares ISAs, Lifetime ISAs, Innovative Finance ISAs, Help to Buy ISAs and Junior ISAs.
When deciding which type of ISA to open, it’s important to understand the pros and cons of each so that you can choose the type that best fits with your personal needs, circumstances and financial goals. At John Lewis Investments we offer stocks and shares ISAs and Junior ISAs.
Tax treatments depend on your individual circumstances and may change in the future.
Types of ISA
Here’s an overview of the six main types of ISA: cash ISA, stocks and shares ISA, Lifetime ISA, Innovative Finance ISA, Help to Buy ISA and Junior ISA.
The cash ISA
Cash ISAs are offered by most high street banks. They work very much in the same way as a normal savings account, except you never pay any tax on the interest you earn in a cash ISA.
There are various types of cash ISAs available, including instant-access accounts and fixed-rate ISAs.
Instant or easy-access cash ISAs let you withdraw your money whenever you want, but normally have a variable interest rate. Fixed-rate ISAs tend to offer slightly higher interest rates than the variable easy-access ISAs, and this rate will remain the same for the fixed term. However, you generally have to pay a penalty if you want to take your money out before the end of the fixed term. It’s important to shop around to make sure you’re getting the best deal for you.
As long as your cash ISA provider is covered by the Financial Services Compensation Scheme (FSCS), up to £85,000 of your money saved with them is protected if your provider goes into liquidation.
Cash ISAs are often seen as a more stable option compared to other ISAs because your money is not invested in the stock market. However, this can come at a cost. The average interest rate offered for cash ISAs is currently quite low, so your savings won’t grow by much over time. What’s more, low interest rates coupled with higher inflation may actually mean that, over time, the real value of your money goes down. John Lewis Investments does not offer cash ISAs.
The Lifetime ISA (LISA)
The Lifetime ISA is a government initiative to encourage those aged between 18 and 39 to put money aside for their first home or retirement. The Lifetime ISA is available as a cash ISA or a stocks and shares ISA. You’re allowed to hold a Lifetime ISA alongside other cash, stocks and shares, or Innovative Finance ISAs. You may have more than one Lifetime ISA, but you can only pay into one each tax year.
So how does it work? If you’re eligible to open a Lifetime ISA, you can contribute up to £4,000 each year until your 50th birthday and receive a 25% bonus on your contributions from the government. You can keep money in this account until you turn 60 and then you can take it out to use for whatever you like, or you can use it to buy your first home at any time before you’re 60. You can also withdraw from your Lifetime ISA if you’re terminally ill and have less than 12 months to live. If you withdraw for any other reason, you’ll be charged a 25% government penalty on the amount you take out.
If you plan to use the Lifetime ISA to buy your first home rather than to save for retirement, there are a few important rules to bear in mind, particularly that you have to:
- be a first-time buyer and not own property anywhere in the world
- live in the house you’re buying
- buy the home for £450,000 or less.
- have had the Lifetime ISA open for at least 12 months
John Lewis Investments does not offer Lifetime ISAs.
The Innovative Finance ISA
The Innovative Finance ISA is a peer-to-peer (P2P) investment wrapped up in an ISA. So you’re able to invest in peer-to-peer lending platforms without paying capital gains tax on your returns.
If you invest in P2P lending you may get a better interest rate than through a high street bank savings account. But the risks are greater, too. If the ‘peer’ you lend to doesn’t perform as expected, you could bear the brunt of any losses, and those losses are final if they default on a payment.
Liquidity can also be an issue if you want to withdraw your money before the end of the term of the loans you’ve made.
Innovative Finance ISAs aren’t currently backed by the Financial Services Compensation Scheme (FSCS), so you may want to approach these ISAs with caution.
John Lewis Investments does not offer Innovative Finance ISAs.
The Junior ISA (JISA)
A Junior ISA is a way to start building up savings for children as early as possible. All children resident in the UK can have one. A parent or legal guardian can open it on the child’s behalf; 16-year-olds can open a Junior ISA for themselves. Anyone, including family and friends can add money to a Junior ISA. Once the child turns 18, the Junior ISA automatically converts to an adult ISA.
You can transfer an existing child trust fund (CTF), for which investments are made in cash, into a Junior ISA. As with their adult counterparts, Junior ISAs are tax efficient. You can open a Junior stocks and shares ISA or a Junior cash ISA.
The Junior ISA allowance for the 2023/24 tax year is £9,000.
What is ISA flexibility?
ISA flexibility refers to whether you’re able to withdraw from your ISA without affecting your annual allowance. If an ISA is flexible, you can withdraw money from it and then put money back into it, within the same tax year, without affecting your annual ISA allowance. It applies to money deposited in the ISA in previous years as well as money you’ve contributed in the current tax year.
Let’s look at an example:
You have £35,000 in a flexible cash ISA. This is made up of £25,000 from previous tax years and £10,000 that you’ve contributed during this tax year. The current ISA allowance is £20,000 per tax year, which means you still have £10,000 of your allowance remaining. You decide to withdraw £15,000. Because it’s a flexible ISA, you’re still able to contribute a further £25,000 in the current tax year – this is made up of the £15,000 you took out and the £10,000 remaining of your annual year allowance.
If an ISA is not flexible it means that if you withdraw money, that part of your annual allowance remains used. So, if you had already reached the ISA allowance limit and then decided to take money out, you would not be able to put the money back into an ISA within that tax year.
Flexible ISAs are normally cash ISAs, but not all providers offer flexible cash ISAs. However, cash ISAs are not the only ISA types that offer flexibility – depending on the provider, you may be able to get flexibility within an Innovative Finance ISA and for the cash held within a stocks and shares ISA. Flexibility is not available for Lifetime ISAs and Junior ISAs. Make sure you check with your provider to ensure your ISA meets your needs. John Lewis Investments does not offer flexible ISAs.
Who can open an ISA?
To open an ISA, you have to be a UK resident for tax purposes. You can only open an ISA for yourself and not with, or on behalf, of someone else - except in the case of a Junior ISA.
Specific ISAs have different restrictions in terms of how old you need to be to open one. You have to be:
- 16 or older to open cash ISA
- 18 or older to open a stocks and shares ISA or an Innovative Finance ISA
- between 18 and 39 years old to open a Lifetime ISA
- between 16 and 18 years old to open a Junior ISA for yourself
- 18 or older to open a Junior ISA for a child, assuming you’re the child’s parent or legal guardian.
What is the difference between an ISA and a savings account?
There are a few differences between an ISA and a savings account that are worth knowing.
The biggest differences between a regular savings account and an ISA are:
- Savings accounts generally don’t have an annual contribution limit, whereas ISAs have a government-specified annual allowance.
- With regular savings accounts, you save your money as cash; if you open an ISA, you can choose to save in cash, invest in stocks and shares, or invest in peer-to-peer lending.
- Depending on your personal circumstances and income tax rate, you’ll have to pay tax on any interest earned in a savings account that is over your personal savings allowance. For an ISA, you never pay tax on any growth, returns or interest earned. The interest earned in an ISA doesn't count towards your personal savings allowance.
- When you die, ISA allowances can be passed on to your spouse or civil partner more tax efficiently than money in a regular savings account.
There are also some similarities between ISAs and savings accounts. For example, both have account types that allow you to access your money easily without paying a penalty fee, and both have account types where you can put your money into the account for a fixed amount of time at a certain interest rate.
Whether you choose an ISA or a regular savings account, the choices you make around where and how to invest or save money will depend on your personal circumstances, goals, the length of time you want to put your money away for and the level of risk you are willing to take with that money.
How many ISAs can you have?
You can have as many stocks and shares ISAs, Lifetimes ISAs, cash ISAs, and Innovative Finance ISAs as you want, but you can only open or contribute to one of each of these types in any one tax year.
You can only have one stocks and shares Junior ISA and one cash Junior ISA if you’re under 18. However, if you’re between 16 and 18 years old you can also have a cash ISA.
You can decide how to use your annual ISA allowance across the different ISA types you’re eligible for. You’re able to split the amount any way you like between the different ISA types across the tax year. However, you can only contribute up to £4,000 into a Lifetime ISA each tax year and remember, you can’t put money into more than one ISA of the same type in the same tax year.
Let’s look at an example:
Let’s say you already have a stocks and shares ISA, a Lifetime ISA, and a cash ISA.
You haven’t yet used any of your £20,000 annual ISA allowance for the 2023/24 tax year.
You decide to put £11,000 into your stocks and shares ISA and £4,000 into the Lifetime ISA. You’d still have £5,000 to use across the tax year. You may decide to open a new cash ISA and contribute a portion of your allowance to that, or to contribute to your already established cash ISA instead. However, you couldn’t open a new cash ISA and pay into both that and your existing cash ISA – you can only pay into one ISA type per year.
It’s important to remember that the Junior ISA allowance is separate to the £20,000 ISA allowance. So, if you’re between 16 and 18 years old, you could pay £9,000 into a Junior ISA and still have a £20,000 allowance to contribute to a cash ISA. You can also contribute to someone else’s Junior ISA without affecting your annual allowance.
As with all investing, your capital is at risk. The value of your portfolio with John Lewis Investments can go down as well as up and you may get back less than you invest. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek financial advice.