Six different types of ISA: the pros and cons of each
Individual Savings Accounts, or ISAs, allow people to hold cash or shares in a tax-efficient way.
They are offered by banks, building societies, National Savings & Investments (NS&I) and investment firms or platforms, and you can deposit up to £20,000 per adult in an ISA each tax year. You have until 5 April to use your 2018/19 allowance.
Below is a list of the ISA types, as well as the advantages and drawbacks of each:
1) Cash ISAs
Cash ISAs are the simplest and most popular type of ISA on the market.
A cash ISA is a tax-free way to save money. With other savings accounts, you may have to pay income tax on the interest you earn, but the cash ISA is free from tax, which means you keep all the interest you earn.
Your money (up to £85,000) is also covered by the Financial Services Compensation Scheme (FSCS) which provides protection should the ISA provider go bust.
However, given that average interest rates on cash ISAs are around 1%, savers are missing out on the potential to earn better returns elsewhere.
2) Stocks and Shares ISAs
With a stocks and shares ISA, you have the potential to earn better returns. The average stocks and shares ISA has historically generated around 6 – 7% annual return, although returns can go down as well as up.
Then there are the fees for managing your money to consider. These can take a significant chunk from your investment. Investors can shop around for cheaper options. For example, robo-advisers aim to offer a lower-cost alternative to other platforms and providers.
Given the value of your investments is subject to change, stocks and shares ISAs aren’t suitable for someone with a low risk appetite or a short-term outlook. Instead, this type of ISA is generally for those who can invest their money for at least five years. As with most types of investing, it’s the length of time in the market that is key, and patience can pay.
3) Junior ISAs
A Junior ISA is a great product for under 18s to build up their cash savings. A parent or legal guardian can open a junior ISA at a bank or building society on behalf of the child, or they can select stocks and shares as part of an investment ISA. While the child can take control of the ISA at the age of 16, they can’t withdraw money until they turn 18.
This makes it a family-friendly option for parents looking to get their kids on to the savings ladder. It allows parents to lay the foundations for their child’s financial future by granting long-term tax-free savings, even if the child starts work.
The annual tax-free contribution limit for Junior ISAs is lower, at £4,260 currently, but this will rise to £4,368 in the new tax year in April.
4) Help to Buy ISA
There’s been plenty of discussion around the Help to Buy ISA in recent months, particularly among so-called ‘generation rent’.
A Help to Buy ISA has been specifically designed to help first-time buyers get on the property ladder by providing a 25% government boost to savings.
For every £200 saved, you will receive a government bonus of £50. In your first month, you can deposit a lump sum of £1,200 to get your account started.
But remember, the government bonus contributes to your overall upfront deposit, known as the ‘mortgage deposit’ rather than an ‘exchange deposit’ which is money your conveyancer pays to the seller’s conveyancer.
What’s more, savings can be slow to accumulate, meaning it may take several years to be in a position to buy your first property.
5) Lifetime ISA
Similar to the Help to Buy ISA, a Lifetime ISA (LISA) gives you a government bonus of 25% of the money you put in, up to a maximum of £1,000 a year. This is good news for young savers aged between 18 and 39. But unlike the Help to Buy ISA, the money can be used for your first home or for your retirement income.
But remember, a Lifetime ISA has a 25% charge (of the amount withdrawn) if you decide to take the cash out for anything other than a first home or before you turn 60.
6) Innovative Finance ISA
An Innovative Finance ISA (IFISA) is a peer-to-peer lending or crowdfunding product. In some instances, you can generate returns of around 8 – 9% by lending to private borrowers or by taking stakes in ‘crowdfunded’ investments. The IFISA is also subject to the same £20,000 annual ISA allowance so you can split your money between this ISA, as well as cash and stocks and shares.
While this is regulated by the FCA, peer-to-peer lending is not covered by the FSCS meaning your capital is at risk.
As ever, investments are subject to fluctuation. If in doubt, always seek financial advice from a provider regulated by the Financial Conduct Authority.
Anthony Morrow is co-founder of online investment management service evestor.co.uk