How does an ISA work?

logo

Personal Investments

06 April 2020

If you’re over the age of 16 and live in the UK, you can save up to £20,000 a year tax-free in an ISA. Our guide looks at the different types of ISA available and how each one works.

An ISA, or individual savings account, allows you to benefit from tax breaks. If you hold cash in an ISA, you’ll never pay tax on any interest earned. If you hold investments in an ISA, you won’t be taxed on income or any capital gains you make. So if you complete a tax return, you don’t need to declare any ISA interest, income or capital gains. 

What is the ISA allowance?

For the tax year 2020-21, the maximum amount you can put in an ISA is £20,000. Once the next tax year begins on April 6, your allowance resets, with the limit decided by the Government.

If you don’t use up your full ISA allowance in the tax year, you can’t carry it over to the next year, so it’s always best to save as much as you can now to maximise the benefits.

How different ISAs work

Although your overall allowance is £20,000, not all types of ISA will allow you to pay in the full amount.

  • Cash ISA: This works like a regular savings account, except the interest is never taxed. It’s a safe option for your money, which you can build up and grow over time by accruing interest. You can currently pay in up to £20,000 a year.
  • Stocks and shares ISA: You can invest up to £20,000 in the stock market through funds, bonds or shares in individual companies. Returns can be higher than with a cash ISA, but there’s a chance you could also end up with less money than you put in if the value of your investment falls. You will also usually be charged fees for your investments to be managed.
  • Innovative Finance ISA: With this type of ISA, you can lend up to £20,000 to other people through peer-to-peer lending and crowdfunding platforms, and you receive tax-free interest when the loan is repaid. It’s riskier than a cash ISA.
  • Lifetime ISA: You can open a Lifetime ISA if you’re aged between 18 and 40, but you’re only allowed to pay in up to £4,000 each year. The Government will give you a 25% bonus on your savings until you turn 50.

Splitting your allowance

The whole of your overall ISA allowance of £20,000 can be paid into a cash, stocks and shares or Innovative Finance ISA, or you can split it among all five types of ISA as long as you’re eligible. For instance, you could put £5,000 in a cash ISA, £8,000 in a stocks and shares ISA, £4,000 in a Lifetime ISA and £3,000 in an Innovative Finance ISA in the same tax year.

Withdrawing your money

You can take your money out of an easy access cash ISA at any time without losing the tax benefits, but if it’s a non-flexible ISA the money can’t be returned.Flexible ISAs allow you to withdraw and replace money without it counting towards your annual ISA allowance. So if you paid in £10,000 and then withdrew £5,000, you could still pay in another £15,000. But not all ISAs are flexible, so check with your provider before making a withdrawal if you’re not sure.