Individual Savings Accounts (ISAs): they're more than just low interest savings

Over the years, the Individual Savings Account (ISA) has established itself as one of the most tax-efficient ways of saving and investing.

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First introduced in 1999, ISAs have seen many changes - from increasing subscription limits, to the addition of new types of account - but one thing remains the same: there’s no tax to pay on any interest or capital gains. 

Originally offering only Cash, Stocks and Shares (then known as Mini and Maxi ISAs respectively) and the now-defunct Life Insurance accounts, ISAs have grown significantly as of late. 

21 years after the first ISAs were unveiled by the government, there are now a wealth of ISA options available to suit a person’s individual needs and goals.

The newest additions to the ISA family, the Innovative Finance ISA (IFISA) and the Lifetime ISA, have further expanded the benefits an ISA can offer, and the Junior ISA has broadened ISA eligibility - giving those under 18 years old their own ISA allowance.

While Cash ISAs have long been the most popular ISA account, their low interest rates have seen savers and investors become increasingly disillusioned with the returns on offer - prompting a significant move towards investment opportunities that have the potential to target higher rates.

With the new tax year just around the corner - bringing with it a reset ISA allowance - here is an overview of your options for 2020/21 (or the remainder of 2019/20, if you have some of your current allowance left-over).


Cash ISA

Though the Cash ISA is in decline - with 670,000 fewer accounts opened in 2017/18 than in the year previous according to HMRC - it’s still one of the most popular ISAs on the market.

The Cash ISA is similar to a traditional savings account in that it holds only cash. However, the big difference is that a Cash ISA benefits from the well-known ISA tax wrapper, making all interest earned on savings held within the account tax free. 

Any UK resident aged 16 or over is eligible to open a Cash ISA, and Cash ISAs are subject to the annual ISA allowance. In 2019/20, this is £20,000 - but is subject to change.

Cash ISAs are offered by a large range of banks and building societies, and there are multiple different types to choose from, including;

  • Instant-access (or easy-access). Instant-access Cash ISAs do what they say on the tin - you can withdraw funds from the account at any time without incurring any penalties. 

  • Flexible. Flexible Cash ISAs are becoming increasingly common, and they allow you to withdraw and replace cash in your account without affecting your annual ISA allowance.

  • Fixed-rate. A fixed-rate Cash ISA offers savers a fixed-rate of interest for the duration of a set time period, and this rate is often higher than those available on the likes on instant-access Cash ISAs. With a fixed-rate account, your money is usually locked away for a set amount of time, and any early withdrawals could result in a penalty.

Because they’re a savings product, not an investment product, Cash ISAs could be viewed as relatively safe. Your capital is not at risk, and if your authorised Cash ISA provider was to fail and be unable to return your money, you’re protected by the Financial Services Compensation Scheme (FSCS) for up to £85,000. 

However, the low interest rates offered on Cash ISAs often mean they barely beat the rate of inflation, and the value of your savings could be eroded. According to Money Saving Expert, at the time of writing the best instant-access Cash ISA rate on the market is 1.31%. 


Innovative Finance ISA (IFISA)

The IFISA was introduced by the government in April 2016 as a means of enhancing the UKs alternative finance market, and it allows investors to invest in P2P loans or debt-based securities without having to pay any tax on interest or capital gains. 

Read more:download the IFISA guide

Against a background of low interest rates offered by Cash ISAs and a volatile stock market, IFISAs have become an increasingly popular investment option, exceeding the £1 billion investment mark in 2019. 

There are a variety of assets that can be held in an IFISA - proving valuable for all-important portfolio diversification - including;

  • SME loans

  • Consumer loans

  • Property bonds

  • Green energy bonds

The type of IFISA that is suitable for you will depend on your personal goals, circumstances and investor classification. Ultimately though, any UK resident aged 18 or over can open an IFISA.

Read more: what is the best Innovative Finance ISA available?

Depending on the asset you invest into, IFISAs can often offer target returns of between 4% and 8% - though these are not guaranteed, and your capital is at risk. 

The maximum that you can subscribe to an IFISA per year corresponds with the annual ISA allowance, which is £20,000 for the 2019/20 tax year. 

The risk profile of an IFISA is generally mid/high, but this depends on the underlying asset. There is a risk that borrowers will default on their loans and be unable to return your funds, and the IFISA is not protected by the FSCS.

However, your chosen IFISA provider should have processes in place to minimise this risk to the best of their ability. And if your IFISA is asset-backed - such as a property bond for example - generally it could have first-ranking (or equal first-ranking) security on land, property and applicable assets of the borrowers. This varies from platform to platform, and is not guaranteed if a downturn in the economy was to occur. 


Stocks and Shares ISA

Like the IFISA (and in contrast to the Cash ISA), the Stocks and Shares ISA is an investment product that benefits from the same tax wrapper as its ISA siblings, making all profits within the account tax free. 

A Stocks and Shares ISA allows investors to put their money into a variety of different investment products, including;

  • Unit trusts

  • Investment trusts

  • Individual stocks and shares

  • Corporate and government bonds

  • Open Ended Investment Companies (OEICs)

The Stocks and Shares ISA allowance is £20,000 for the 2019/20 tax year, and as with all ISA accounts, you’re only able to open one per year. 

Read more: preparing for the new tax year: how many ISAs can you have?

Stocks and Shares ISAs are generally considered a long term investment option. Because of the volatility of the stock market - that results in Stocks and Shares ISAs having a high risk profile - it’s advisable to keep your investments in the account for at least five years. This gives time for any falls in value to recover. 


Lifetime ISA

The Lifetime ISA is a tax free, government-backed savings or investment account introduced in April 2017 that helps those between the ages of 18 and 50 save for later life, or to purchase their first home.

You must be between the ages of 18 and 39 to open a Lifetime ISA, and you’re only able to add funds to the account up to the age of 50.

Since the Help to Buy ISA closed to new savers on November 30th 2019, the Lifetime ISA is the only alternative offering first time buyers the generous 25% government bonus that helps boost their savings for their first home, but Lifetime ISAs have the added advantage of allowing savers to save - and utilise the government bonus - for retirement too.

The subscription limit for a Lifetime ISA is £4,000 per tax year, and this is deducted from your annual ISA allowance. If you save more than £4,000, you won’t receive the government bonus on the excess. 

If you’re under the age of 60, you can only withdraw funds from a Lifetime ISA if the cash is going towards buying your first home. If it’s not, you’ll incur a 25% penalty. After the age of 60, you can withdraw your funds at any time. 

You can hold both cash and stocks and shares in a Lifetime ISA, and their risk level depends on which of these assets you go for. 

A Cash Lifetime ISA is similar to a Cash ISA in that they’re a savings account, not an investment account, so your capital is not at risk. Cash Lifetime ISAs are also protected by the FSCS for up to £85,000 if your authorised provider was to fail. 

Stocks and Shares Lifetime ISAs have a higher risk profile, because you would be investing your funds directly into stocks and shares, and your funds would be at the mercy of the fluctuations of the stock market.

Stocks and Shares Lifetime ISAs can see a higher return than Cash Lifetime ISAs if your shares perform well, but this is met with the risk that your shares could perform poorly, putting your money at risk.


Junior ISA

Each child under the age of 18 has their own ISA allowance - which is £4,368 for the 2019/20 tax year - that can be subscribed to a Junior ISA. 

A Junior ISA must be opened by a child’s parent or guardian on their behalf, and once the child turns 16 they’re able to take over management of the account - though they’re unable to withdraw any funds until they turn 18 (when the Junior ISA automatically becomes an Adult ISA).

The Junior ISA comes in two forms - a Junior Cash ISA or Junior Stocks and Shares ISA. The former has the same characteristics as an Adult Cash ISA, while the latter has the same characteristics as an Adult Stocks and Shares ISA (apart from a differing ISA allowance).


Deciding where to allocate your ISA allowance

There are now a multitude of options to consider when deciding where to allocate your ISA allowance - much more than there was when they were initially introduced in 1999. 

You don’t have to settle for low yielding Cash ISAs if you don’t want to. If your goal was to save up for your first home, you could take advantage of the government bonus offered on a Lifetime ISA, or if you were open to taking more risks for the potential of higher returns (in contrast to a cash deposit account) an IFISA could be worth considering. 

It’s advisable to seek advice from an independent financial advisor before making any decisions on where you subscribe your money.


The Innovative Finance ISA Guide

The CARLTON Bonds product is available exclusively to experienced investors who are classified as either sophisticated investors, high-net-worth individuals or professional investors and have the knowledge and experience to make their own investment decisions. Investments are high risk and illiquid, your capital is at risk and returns are not guaranteed. Bonds are not protected by the Financial Services Compensation Scheme (FSCS).