ISAs (Individual Savings Accounts) have been around for more than twenty years, but they’re still a key part of financial plans. However, it’s still important to choose the right ISA for you.
The key advantage of saving or investing through an ISA is that they’re tax-efficient. You don’t pay Income or Capital Gains Tax on interest or returns. Each tax year you can place up to £20,000 into ISAs. This sum can either be spread across multiple ISAs or deposited into a single account.
Whilst the Personal Savings Allowance may mean that ISAs aren’t as important as they once were, official figures show they’re still a crucial part of financial planning for millions of people. There are more than ten million Adult ISA accounts.
So, if you’re looking for a new home for your savings, answer these three questions before opening an ISA.
1. What are you saving for?
Your goals should define all the financial decisions you make, including what ISA to open.
Saving a nest egg for a child that you hope to give them in two years will require a different approach than if you’re saving for retirement in 20 years’ time. Setting out your goals can help you stay on track on and pick out the right product for you.
Whilst there are two main types of ISA, Cash and Stocks and Shares, there are several other types that may match your needs.
- If you’re between 18 and 40, a Lifetime ISA (LISA) is an option. Each tax year, you can deposit up to £4,000 into a LISA, which can be held either in cash or invested, until you turn 50. The advantage of a LISA is that you’ll receive a 25% bonus, on top of interest or returns. Deposit the maximum each year and that’s £33,000 of free money. The LISA was set up to help people save a deposit for buying their first home and retirement. So, if you withdraw the money before you turn 60 for a reason other than purchasing your first home, you’ll face a penalty. This will mean losing the bonus and a portion of your own deposits. The penalty is current 25% of the withdrawal made.
- Launched in 2016, an Innovative Finance ISA is used to hold peer-to-peer loans and crowdfunding services. They have the potential to deliver higher returns but come with more risk than traditional ISA investments. For some investors, an Innovative Finance ISA is a way to invest in higher-income tax-exempt returns. However, they aren’t suitable for the majority of investors and you should ensure it matches your risk profile. You can deposit the full £20,000 ISA subscription into an Innovative Finance ISA if you choose.
Your savings goal will also help you decide if using a Cash ISA or a Stocks and Shares ISA is more appropriate.
2. Would a Cash or Stocks and Shares account be suitable?
Whether a Cash or Stocks and Shares ISA would be more suitable will depend on your goal and the time frame for reaching it. Both have their pros and cons that should be assessed in the context of your financial plans.
Cash ISA: With a Cash ISA, you’ll receive interest on your deposits. Assuming you stay within the limit of the Financial Services Compensation Scheme (FSCS), your money is protected. This can provide you with security. However, interest rates are low at the moment and fail to keep up with inflation. This means, in real terms, the value of your savings is falling slowly each year. Over the long term, this can have a significant impact.
A Cash ISA is often more appropriate for short-term saving goals (those within five years) and if you may need access to the money quickly, for example, if it forms part of your emergency fund.
Stocks and Shares ISA: With a Stocks and Shares ISA, your money will be invested. This provides you with an opportunity to grow your savings at a faster pace than inflation. However, investment values can experience volatility in the short term and it’s an option that comes with risk.
You should only invest if your time frame is a minimum of five years and you can afford to lose money. Investments can be tailored to suit your risk profile, but all investments contain some level of risk. As a result, a Stocks and Shares ISA is often appropriate if you’re planning for the long term and have other provisions in place to act as a safety net if needed.
3. Will you be covered by the Financial Services Compensation Scheme?
Finally, it’s important to understand if your money is protected. The FSCS can offer you the reassurance that if something did happen to the bank or building society you’re saving with, your money won’t be lost.
If you’re using a savings account, up to £85,000 per bank, building society or credit union is protected. This includes ISA accounts. The FSCS will also protect qualifying temporary high balances, for example, if you’ve received an inheritance, for up to six months from when the amount was deposited. As a result, if your ISA exceeds £85,000, it’s worth using several different accounts where possible.
Crucially, the FSCS £85,000 limit is per financial institution. So, if you have several accounts with the same provider or with institutions that act under the same licence, make sure you don’t exceed the limit across these accounts. For example, if you hold two accounts with Halifax and Bank of Scotland, which operate under the same banking licence, only £85,000 would be protected across the two.
Some investments also fall under the FSCS. However, you’d only be covered in the event of a firm failing. If your investment values fall you would not be entitled to compensation. Find out more here.
Is an ISA the right place for your savings?
Whilst ISAs play an important role in many financial plans, that doesn’t mean it’s the right choice for you.
Considering what your goals are may highlight that other products for saving or investing are more appropriate. For instance, if you’re saving for retirement, and have yet to make the most of your Annual Allowance, a pension may be better suited. Speak to us today to discuss your life goals and the financial steps you can take to achieve them.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.