ISA or Savings Account: Which option is best for you?

Individual Savings Accounts (ISAs) were introduced back in 1999 to encourage people to save more. At the time they were trumpeted as a departure from normal savings accounts, as they allowed account holders to earn interest on their savings without paying tax. 

The subsequent recession and enduring, almost flat-lining of interest rates have taken the shine off them somewhat. But, if interest rates continue to rise, there’s no reason to think the appeal of ISAs may also show signs of recovery.

How do ISAs work?

Unlike other savings, there are limits on how much you can put in ISAs each year. For the current tax year, which began on 6 April, that’s £20,000, £4,000 for a lifetime ISA or £9,000 for a junior ISA. 

You’re free to place the whole of your allowance in a cash or stocks and shares ISA or split it between the various types, such as a cash, investment or lifetime ISA, within reason (more on that later).

Until recently you couldn’t take any money out of an ISA and put it back in without losing its tax-free status. Currently, if you have a flexible ISA, you can make withdrawals and replace what you take out. Just make sure you know how many withdrawals and subsequent deposits you can make beforehand, as not all ISAs are the same.

Incidentally, when you die, your ISA savings can be passed, tax benefit intact, to your spouse or civil partner. 

How many ISAs can I have?

You can split your allowance across multiple accounts during the tax year.

For example, you could open a new cash ISA, and deposit your full £20,000 annual allowance. Alternatively, you could divide your allowance, popping £10,000 in a cash ISA and the same amount in an investment ISA (also known as a stocks and shares ISA). 

The following year you could open a new cash ISA, for example, while keeping any money you have in last year’s ISAs. If you kept to this pattern you’d have a fistful of cash ISAs after five years, unless you transferred the previous year’s ISAs to your better-paying new ISA.

It’s worth noting that money in previous years’ ISAs don’t count toward your current year’s allowance.

Types of savings accounts

Savings accounts come in many flavours, although the vast majority can be grouped together as follows (which are all available as cash ISAs):

• Easy access accounts: As the name suggests these accounts, ISA or not, allow you to deposit or withdraw cash as you see fit. There may be a short delay, of a day or two to complete withdrawals, hence easy access, and this is what differentiates them from instant access accounts.

• Regular savings accounts: A step up from easy access, regular savings accounts require you to commit to putting a minimum amount into your account on a regular basis. Withdrawals are usually allowed, although you should read the T&Cs.

• Notice accounts: Less common now, but there are still a few floating around. These accounts will allow access to funds saved, although you may have to wait for up to 120 days to make a withdrawal. Unlike easy-access accounts, they’re not ideal for storing emergency cash but can be useful for big-ticket purchases, such as weddings or home deposits.

• Fixed-rate savings accounts: The go-to option if you’re serious about saving for a home deposit, your retirement or another large plan that will take years to reach fruition. With fixed-rate savings accounts, you commit to locking your money away for up to five years, typically, in return for good interest rates.

Specialist ISA accounts

Aside from the above standard savings accounts, there are a few choice Cash ISAs that could appeal, depending on your circumstances. These are:

• Junior ISA: if you’re a parent or guardian, you can open a junior ISA for your child, and plant up to £9,000 in the account each year. Your child can take control of where their money goes from age 16, but can’t make any withdrawals until they reach 18. At 16, your child can open a cash ISA (and deposit up to £20,000 a year), while still putting up to £9,000 in their junior ISA. 

• Lifetime ISA: If you’re aged 18 to 40, you can open a lifetime ISA and put up to £4,000 each year in a until you turn 50. By saving in this tax-free account, you’ll be rewarded with a 25% bonus on your savings. After 50 your account will stay open and keep earning interest. You’ll only get the 25% bonus if you use the money to buy your first home, or after celebrating your 60th birthday (or sooner if you receive a terminal diagnosis). 

• Innovative finance ISAs. These are peer-to-peer investment vehicles, where you invest in individuals, businesses or property developers. Along with Lifetime ISAs, you must be at least 18 to open one.

Are ISAs worth it?

For many years now the tangible benefits of cash ISAs have been largely absent. This is because of the Personal Savings Allowance (PSA), which allows basic taxpayers to earn £1,000 of interest on savings tax-free. With interest rates of around 2% if you’re lucky, this is a sum most of us would struggle to get anywhere close to. 

If you had a savings account earning 2%, you’d need to have a lump sum of over £50,000 before your annual interest earnings broke the £1,000 mark. The problem has been that cash ISAs have tended to pay less in interest than normal savings accounts, so the tax-wrapper benefit has been nothing more than the emperor’s new clothes for most savers. 

However, as interest rates have risen, the amount you need saved up to hit that allowance has vastly reduced.

In this case, the appeal of ISAs, even if they do pay a tad less than normal savings accounts, could improve.