The individual savings account, or ISA, is a tax-advantaged savings vehicle available to UK residents.
There are several different types of ISAs, each with its own set of pros and cons.
In this article, we’ll take a closer look at various ISA advantages and disadvantages so you can decide if opening one is right for you.
Note: For more information on what an ISA is and the different types of individual savings accounts you can have, take a look at this insightful guide.
ISAs are one of the most popular ways to save money in the UK.
Here is a brief overview of the various ISA benefits available to British residents:
One of the biggest advantages of an ISA is that you don’t pay tax on your returns. In other words, all interest earned from investments in your stocks and shares ISA (profit from share price increases, interest on bonds, or dividend income) is not liable to income or capital gains tax (CGT).
This means that you can keep more of your money in your account and let it grow over time. If you are in a higher tax bracket, the tax savings could be even greater.
If you have an easy-access cash ISA you can withdraw money at any time without paying tax. Bear in mind though that different providers limit the amount of times you can make withdrawals and these ISAs typically come with variable interest rates. Also, if you hold a fixed-rate cash ISA you will not be able to withdraw any funds while your money is locked.
Note: In terms of stocks and shares ISA, withdrawals are not recommended as these accounts work best over a longer period of time.
You can save in a variety of different ways, choosing from cash, unit trusts, corporate and government bonds, and investment funds. This gives you a lot of flexibility when it comes to how you save your money.
What’s more, ISAs offer a wide range of investment opportunities that can be tailored to your specific needs. Whether you are looking for long-term growth or setting up a nest egg for retirement or your child’s future, there is an ISA that can fit your savings goals.
You can also move your money between different types of ISAs, and even between providers, without having to pay any tax on the gains. This way you can take advantage of competitive interest rates and switch providers if you find a better deal.
Note: Different providers may have different rules about how many times you can transfer your ISA and what happens to the money you’ve already saved. Always read the fine print before transferring.
Anyone over the age of 18 can open an ISA, while parents/guardians can open a Junior ISA when their child is 16. This makes them a popular choice for younger people who are just starting to save for their future.
ISAs also offer tax benefits for pensioners, allowing them to save money before or after they retire as these accounts do not have upper age restrictions. A self-investment personal pension (SIPP), on the other hand, has an upper age limit of 75.
If your spouse or civil partner died after April 2018, you can inherit their ISA allowance and add it to your account along with your regular annual allowance. While it might not be considered a large inheritance, it is still an advantage of ISAs over other types of savings accounts.
Note: The money you can add to your account must not exceed the value of the ISA when your partner/spouse died or the value of the ISA when it was closed.
While there are many ISA benefits to UK residents, there are also some drawbacks that you should be aware of.
The amount you can contribute to an ISA is limited each year. The limit is set by the government and it changes every financial year. For the 2022/2023 tax year, the maximum allowance is £20,000.
Even though you can spread the allowance over several types of ISAs, you are still restricted with the amount of money you can put in your accounts, which is not the case with Personal Savings Accounts (PSA).
Another downside is that your yearly allowance does not carry forward. So, if you don’t use all of your £20,000 allowance in the tax year, you will lose it.
Every time you invest your money, even if it is a low-risk investment, you are taking a gamble. Your investments could lose value, so it is important to do your research and speak to a professional before picking a provider and an investment opportunity.
There are some types of ISAs that do not allow you to withdraw money whenever you want. So if your ISA is not flexible, the money you take out will count towards your ISA allowance. Even with a flexible ISA, the money you withdraw has to be put back into the account by the end of the tax year, otherwise, you lose your ISA tax benefits.
ISA accounts may not be the best option for short-term investors as they tend to work best over a longer period of time (at least 5 years for stocks and shares ISA). This is because you are unable to withdraw any funds while your money is locked in the account—another reason why you should consult an expert who will guide you towards the best ISA for your needs.
ISAs can be a great way to save money as the interest you earn is tax-free. This is particularly beneficial to higher rate taxpayers, i.e. those who earn well above the median UK salary, or savers have who have accumulated a lot over the years. On the downside, you are limited with how much you can contribute each year and not all types of ISAs allow you to access your money whenever you want.
That is why it is important to weigh up the pros and cons before opening an ISA. Talk to an expert consultant who will be able to help you find the right savings account for your needs.
The biggest drawback is that you are limited in how much you can contribute each year. Additionally, if you need to access your funds, you may have to pay a penalty, which can reduce your savings. Lastly, your investments could lose value, so it is important to do your research before investing.
ISAs, especially cash ISAs are considered safe, as your money is not technically invested into any assets. Your funds in a cash ISA are also covered by the Financial Services Compensation Scheme (FSCS), a government-backed scheme that protects your savings up to £85,000 per person, per financial institution.
This is not the case with a stocks and shares ISA. Here the likelihood of losing or regaining your money depends on where it is invested.
A Lifetime ISA is an account that can be used to save for retirement or as a deposit for your first home. The account has a limit of £4,000 per year and you can receive a government bonus of 25% on contributions, which is one of the main advantages of a LISA.
As with other ISAs, the money you put in and the interest you earn is tax-free.
However, when touching upon Lifetime ISA pros and cons, it’s important to mention that the money you contribute every year to your LISA cannot be accessed unless you are using it as a deposit to buy your first home, before you are 60 or if you are terminally ill. If you withdraw money from your account for any other reason, you will lose your government bonus and pay a 25% exit fee leaving you with less money than what you have saved.
Here is a breakdown of ISA advantages and disadvantages and how they compare to savings accounts:
|Can only contribute up to £20,000 per tax year||Deposits are not limited|
|Tax-free||You pay tax on interest that exceeds your personal savings allowance|
|Flexibility in investment products||Only cash investments|
|You can only open one type of ISA a year||No limit on the number of accounts you can open|