Individual Savings Accounts (ISAs) are sometimes viewed as go-to investment products for investors who wish to make the most of tax-free allowances to meet their financial goals.
What is an ISA?
Effectively, an ISA is a tax-free wrapper into which investors can save or invest up to £20,000 a year, under current rules for the tax year April 2024/25.
There is no capital gains tax (CGT) levied on any growth on investments in an ISA, nor tax on income or interest, so there is no need to declare ISAs on your tax return. These vehicles therefore provide an easy, tax-efficient way to invest, either for the medium or long term.
Different types of ISAs
While people typically talk about either cash or stocks and shares ISAs – as most ISAs will be either cash or stocks and shares – in fact there are several different types of ISA available to investors depending on their circumstances. These are:
- Cash ISA
- Stocks and shares ISA
- Innovative finance ISA
- Lifetime ISA
- Junior ISA
Cash ISAs
Cash ISAs are simple savings accounts, with the added benefit that any interest earned on your savings are tax-free as explained above. Cash ISAs are typically low risk, especially in comparison to stocks and shares ISAs. However, while rates on cash ISAs have risen recently, over the medium to long term they are likely to be outperformed by returns on stocks and shares ISAs, while the current high-inflation environment will erode your cash in real terms.
Stocks and shares ISAs
Stocks and shares ISAs can be invested in individual shares and investment funds. They tend to be a riskier option than cash ISAs as a result, but also offer the potential to enjoy higher returns over the longer term, such as five years or more.
Learn more about Liontrust's Stocks and Shares ISA.
Innovative finance ISAs
An innovative finance ISA (IFISA) is typically a higher-risk option than either a cash ISA or stocks and shares ISA. This is because an IFISA is a tax-free wrapper around peer-to-peer (P2P) loans. This means people investing in an IFISA are putting their money into lending to other borrowers, typically small businesses and individuals, through intermediary lending platforms such as Zopa or Ratesetter.
The benefit of investing in this way is that the rates of interest typically paid on such loans are higher than on savings accounts offered by banks or building societies. The risk however, is that borrowers default on their loans or even that businesses go into insolvency, potentially putting your money at risk.
Lifetime ISAs
Lifetime ISAs (LISA) were launched by the government in 2017 with the aim of helping younger people to get onto the property ladder or save for retirement. As a result, and in contrast to the different ISAs mentioned above, LISAs are only available to people aged 18-39.
The maximum amount that can be saved into a LISA each year tax-free is £4,000 for the tax year to April 2024. However, investors can still benefit from the full £20,000 annual tax-free allowance if they choose to take out another ISA alongside the LISA – as long as the total amount invested does not exceed the £20,000 annual limit.
Only one LISA can be opened or held every year, though it is possible to open a new LISA every year providing you are still within the age limits.
Who can save into an ISA?
UK residents aged 18 and over can save into either a cash or stocks and shares ISA, or both or even all four depending on eligibility (with the limits on LISAs as above), but in any one tax year the allowance limit is £20,000 in total (for the tax year April 2023/24).
Allowances cannot be rolled over into subsequent tax years, so investors must have invested each annual allowance by the end of the tax year (5th April).
By investing in ISAs, investors can access a wide range of asset classes to create portfolios with strong diversification qualities, which helps to address potential risks.
No upper limit on ISA portfolios
Although there are annual limits on contributions into ISAs, there is no upper limit on how much can be accumulated. Over time, stocks and shares ISAs can be used to build up substantial portfolios in shares and bonds (either directly or via funds), as well as commercial property and commodities via funds.
Increasingly, the range of investment options include ‘sustainable’ investments, which can help to bring about positive environmental and social impacts while still delivering a financial return.
Stocks and shares ISAs offer a tax-free solution for those wishing to build up cash lump sums to pay for specific purposes such as school and university fees, for example, or to supplement retirement income. ISA assets can also be passed on to surviving spouses or civil partners, who can retain their benefits of tax-free income and growth.
Junior ISA
A Junior ISA (JISA) is simply an individual savings account (ISA) designed for children under the age of 18, who are resident in the UK.
Parents and legal guardians can set up a JISA in a child’s name and save or invest up to the annual tax-free allowance, which is £9,000 for the tax year to April 2024.
As with other ISAs, a JISA can take the form of a cash JISA or a stocks and shares JISA. Money saved into a cash JISA will be free of tax on any interest earned. Meanwhile those investing in a stocks and shares JISA will not pay tax on any capital growth or dividends that are received.
Learn more about Liontrust's Junior ISA.
Who controls a JISA?
The parent or guardian controls the JISA on behalf of the child until they reach the age of 16 – at which point holders have access to their account and can control it themselves.
However, no withdrawals are allowed from a JISA until the child reaches 18 years of age, when the account is automatically converted into a standard adult ISA. Once the account becomes a general ISA, it can be used by the named holder for anything they wish, such as helping them through university or putting down a deposit on a home.
Other points to note
Many parents or guardians may have put money away in the government-backed Child Trust Fund (CTF) with the aim of providing for their child’s future. These have been closed for new applications since 2011 when they were replaced by Junior ISAs.
For those who have an existing CTF, it is worth noting that it is not possible to have both a JISA and a CTF. However, some ISA providers will offer the facility to transfer funds from a CTF into a JISA, though not all do.
