There are four types of adult ISA currently available:
- Cash ISA
- Stocks and Shares ISA
- Innovative Finance ISA (IFISA)
- Lifetime ISA
There's also a fifth type of ISA, designed specifically for children and young people, called the Junior ISA.
The Cash ISA is a form of savings account that is offered by UK regulated banks and building societies.
They are the most popular (and simplest) type of ISA on the market. They're a tax free way of saving money, meaning you keep all of the interest that you earn, provided your deposits remain within the annual tax-free ISA allowance (currently at £20,000 for the 2022/23 tax year).
There are three types of Cash ISA which include;
Instant-access Cash ISA
This allows you to pay in or withdraw money at any point without a penalty, though some providers may impose limits such as the amount you can withdraw before a penalty charge. Some instant access Cash ISAs also provide a short term bonus if funds are not withdrawn in a certain period such as a 12 month term.
Many providers of Instant Cash ISAs will allow unlimited further additions which make them ideal for those wanting to regularly add to their savings.
Flexible Cash ISA
These types of ISAs work by allowing savers to withdraw any money from their account without it affecting their Tax Free ISA allowance, so long as the money is replaced within the same tax year. Not all providers offer Flexible Cash ISAs and some providers only offer this on variable rate ISAs.
An example of how a Flexible Cash ISA works could be: You deposit £6,000 into your Cash ISA at the beginning of the Tax year, which leaves you with £14,000 of your tax-free ISA allowance. Let’s say you withdraw £3,000 in the August which decreases your balance to £3,000. This means you can still pay an additional £17,000 into the ISA within the same tax year. You repay £3,000 into your Flexible Cash ISA in January which increases your balance to £6,000 and you are still able to pay a further £14,000 in the same tax year.
Fixed-rate Cash ISA
With a fixed-rate Cash ISA, you’ll need to be willing to lock your money away for a fixed amount of time. This is rewarded with a fixed interest rate, generally meaning the longer the term, the more interest you’ll earn. By law cash ISA providers must allow access to your money whenever you want it.
However in order to get your cash, some Cash ISA providers require you transfer out or close your account in order to get your cash. Currently the average returns of a five year fixed-rate Cash ISA stand at between 1%-2%, although some of these providers require a minimum investment amount in order to secure these rates.
With a Cash ISA, up to £85,000 of your money is protected by the Financial Services Compensation Scheme (FSCS) or £170,000 for joint accounts, should your ISA provider go bust. It is important to know that some banking brands are part of the same authorised firm. This means if you have more than the FSCS protected amount in your account, it is good to move the excess into another bank or building society under a different authorised firm. You can check to see which banks are part of which authorised firms on the Bank of England website.
Cash ISAs can be opened by anyone over the age of 16 who lives in the UK. They are aimed at individuals wanting to save in a low-risk way with easy access to their savings. Cash ISAs mean you still have easy access to your money whenever you need it. If you’re certain that you won’t need early access to your funds though, a fixed-rate Cash ISA allows you to potentially earn higher rates of interest, giving your savings a little boost.
Cash ISAs will be most beneficial for individuals who require instant access to their savings. However, it’s worth keeping in mind that although Cash ISAs are the safest form of ISA, they also offer the lowest rates of interest - these range from just over 0.7% up to 2.25% over a five year term.
STOCKS AND SHARES ISA
A Stocks and Shares ISA is a tax efficient investment account that allows you to put your money into a range of different investments, but - due to the fact that the value of your investments can go up as well as down - they may not be suitable for an investor with a low risk appetite.
Average returns on a Stocks and Shares ISA are around 7.5% over the long term, which is well ahead of inflation and the returns from Cash ISAs. That said it is important to understand that the value of investments in a Stocks and Shares ISA are subject to change and unlike holding your money in a bank deposit account such as an Cash ISA, capital is not protected should your investments fail.
Stocks and Shares ISAs are likely to be a better choice for investors with a long term outlook and those looking to protect any profits or interest from tax. Investors into Stocks and Shares ISAs should also be prepared remain patient when it comes to this type of investing, with their investment potentially remaining in a Stocks and Shares ISA for a minimum of five years and returns not guaranteed. If your fund manager goes bust, you can claim compensation of up to £85,000 from the FSCS (if your fund manager is covered) per person, per institution.
Although it is advisable to hold your investments for no less than five years, there is no minimum amount of time you must hold your Stocks and Shares ISA before selling the assets held in it, you can do this at anytime. However, if you choose to cash in some or all of your Stocks and Shares ISA, you are only able to reinvest the money into another ISA to the extent that you have unused ISA allowance.
Many Stocks and Shares ISAs will charge a fee for both using the platform and for buying funds, often taking a considerable amount from your investment. However there are cheaper alternatives if investors take the time to compare providers and can even make use of a service such as a robo-advisor. Robo-advisors are increasingly growing in popularity which enable investors to access digital financial advice and select stocks and shares this way.
INNOVATIVE FINANCE ISA (IFISA)
Introduced by the government in 2016, Innovative Finance ISAs (IFISAs) are one of the latest additions to the ISA family.
An IFISA allows you to use some, or all, of your annual ISA allowance (currently £20,000 in 2022/23) to lend funds through the peer-to-peer (P2P) lending market while receiving tax free interest and capital gains. In some instances you can generate returns of around 3%-15% with an IFISA by taking stakes in ‘Crowdfunded’ investments and lending to private borrowers in Property, Green energy, SME lending and Consumer lending markets.
The simplest way of explaining IFISAs is that it is an ISA that contains peer-to-peer loans instead of cash. Investors are matched with borrowers who are typically businesses, property developers or individuals. IFISAs have the potential to offer much higher rates of returns when compared to Cash ISAs. The reason being is that by cutting out a bank and investing in an IFISA through an online portal (also known as peer to peer lenders) there are usually no hidden fees to pay that can cut the level of interest returned.
Despite IFISAs growing in popularity with over £1billion invested in them since 2016, many inexperienced investors are unaware of their high risk profile.
Any type of investment carries an element of risk and IFISAs are no different, so much so that in December 2019, the Financial Conduct Authority (FCA) implemented a new rule that prevents individuals from investing more than 10% of their assets in peer to peer investments unless they have taken financial advice. Although regulated by the FCA, P2P lending is not protected by the FSCS, meaning your capital is at risk and returns are not guaranteed.
There are various IFISA-specific rules to be aware of, but as with all ISAs the IFISA benefits from tax free returns, and can be opened alongside other ISAs such as a Stocks and Shares ISA, Lifetime ISA, and Cash ISA. However only one IFISA can be opened at any one time, although transferring IFISAs is possible depending on the provider.
IFISAs are great for people who want a greater level of risk in their investment portfolio. They can offer better returns than is available through a Cash ISA and when comparing IFISAs to Stocks & Shares ISAs, they can offer more assurances in regards to security, making them the perfect middle ground.
A Lifetime ISA is a government-backed savings scheme designed to help people buy their first home or save for retirement. The government pays a 25% bonus on whatever you save - up to a maximum of £1,000 per year - which is paid into your Lifetime ISA account each month.
If you are using your Lifetime ISA to save to buy a home, you must be a first time buyer. If you are using it to save for retirement, you can only pay into the account until you are 50, and you must wait until you turn 60 to withdraw funds.
If you’re saving to buy your first home, you now only have the option of saving with a Lifetime ISA rather than a choice of the Help to Buy (HTB) ISA (if you didn't already open a HTB ISA before the 30th Nov 2019).
As far as first time buyers are concerned, a Lifetime ISA offers the same amount of Government Bonus (25%) as the former Help to Buy ISA offered, the main difference being, you can only use your Lifetime ISA to buy your first home 12 months after your first payment into the account. If funds are withdrawn before this time, the 25% government withdrawal charge is payable.
A maximum of £4,000 can be placed into a Lifetime ISA each year, all of which is linked to your annual ISA allowance. Whilst you can only have one Lifetime ISA account at any one time, you can still spread your annual ISA allowance across different types of ISAs such as a Stocks and Shares ISA or an Innovative Finance ISA.
The Junior ISA is a specific product designed for under 18s to build up cash savings for their future. There are 2 types of Junior ISAs available which are: A Junior Cash ISA (available through banks or building societies) or a Junior Stocks and Shares ISA.
Junior ISAs are aimed at parents or guardians to save for a child’s future, which can be a worthwhile savings account (if selecting a Junior Cash ISA) or investment account (if selecting a Junior Stocks and Shares ISA).
Both types of Junior ISAs can provide long term, tax free earnings for a child's financial future, however the type of ISA you choose (both or just one) will depend on your attitude towards risk and which product is most suitable for your financial goals and circumstances.
The Junior Cash ISA is available to anyone under the age of 18 living in the UK, and can be opened by a child's parent or legal guardian who can enable saving on behalf of their child. The child will then be able to take control of the ISA at the age of 16, but must wait until the age of 18 to withdraw any money.
With tax free returns of up to 3.6% per annum the Junior Cash ISA is a family friendly method of laying the foundations for your child's financial future with tax free earnings, even if the child starts work.
Junior ISAs are a great way to kick-start a child’s savings, and they receive the same tax free benefits as adult ISAs. The allowance for Junior ISAs is lower than adult ISAs however. For the 2020/21 tax year, the Junior ISA allowance is £9,000.
Though Junior Stocks and Shares ISAs have the potential for larger returns, they also have more risk attached as the value may fall, meaning your child could get back less than has been paid in. Although Junior Cash ISAs don’t see as higher returns as the potential of a Junior Stocks and Shares ISAs, they are by far the safer option, with all savings protected by the Financial Services Compensation Scheme (FSCS) up to £85,000.
Opening a Junior ISA for your child could eventually help them pay for higher education, buy their first car or put down a deposit on their first home - as well as giving you the peace of mind that the foundations for your child’s financial future are firmly in place.
CARLTON Bonds are an IFISA provider specialising in fixed term property bonds.
Against a backdrop of low interest rates and a volatile stock market, the IFISA can provide an attractive investment opportunity for experienced investors.
With the ability to hold peer-to-peer loans and debt-based securities, IFISA investments have the potential to generate higher rates of return than more traditional investment routes for investors with a greater appetite for risk.
To find out more about making the most of your annual ISA allowance, download our free guide.