What is an ISA? ISAs Explained | Nutmeg - Nutmeg (2024)

What is an ISA?

An ISA is an Individual Savings Account. It’s a special type of account that gives you the opportunity to save or invest a certain amount of money every year, without having to pay tax on any growth in your investments or savings.

Here’s how it works. Each tax year (6th April to 5th April), the government gives everyone in the UK aged 18 and over a tax-free allowance that you can put into ISAs. This amount is known as your ISA allowance. For the current tax year the ISA allowance is £20,000. If you don’t use your whole allowance in a tax year it doesn’t roll over to the next year. So, the moral of the story is use it or you’ll lose it.

Understanding ISAs isn’t as complicated as you might think. However, there are many different types of ISA available, including cash ISAs, stocks and shares ISAs, Lifetime ISAs, Innovative Finance ISAs, Help to Buy ISAs and Junior ISAs.

Types of ISA

Here’s an overview of the six main types of ISA: cash ISA, stocks and shares ISA, Lifetime ISA, Innovative Finance ISA, Help to Buy ISA and Junior ISA.

The cash ISA

Cash ISAs are offered by most high street banks. They work very much in the same way as a normal savings account, except you never pay any tax on the interest you earn in a cash ISA.

There are various types of cash ISAs available, including instant-access accounts and fixed-rate ISAs.

Instant or easy-access cash ISAs let you withdraw your money whenever you want, but normally have a variable interest rate. Fixed-rate ISAs tend to offer slightly higher interest rates than the variable easy-access ISAs, and this rate will remain the same for the fixed term. However, you generally have to pay a penalty if you want to take your money out before the end of the fixed term. It’s important to shop around to make sure you’re getting the best deal for you.

As long as your cash ISA provider is covered by the Financial Services Compensation Scheme (FSCS), up to £85,000 of your money saved with them is protected if your provider goes into liquidation.

Cash ISAs are often seen as a more stable option compared to other ISAs because your money is not invested in the stock market. However, this can come at a cost. The average interest rate offered for cash ISAs is currently quite low, so your savings won’t grow by much over time. What’s more, low interest rates coupled with higher inflation may actually mean that, over time, the real value of your money goes down.

The Lifetime ISA (LISA)

The Lifetime ISA is a government initiative to encourage those aged between 18 and 39 to put money aside for their first home or retirement. The Lifetime ISA is available as a cash ISA or a stocks and shares ISA (although Nutmeg only offers a stocks and shares Lifetime ISA). You’re allowed to hold a Lifetime ISA alongside other cash, stocks and shares, or Innovative Finance ISAs. You may have more than one Lifetime ISA, but you can only pay into one each tax year.”

So how does it work? If you’re eligible to open a Lifetime ISA, you can contribute up to £4,000 each year until your 50th birthday and receive a 25% bonus on your contributions from the government. You can keep money in this account until you turn 60 and then you can take it out to use for whatever you like, or you can use it to buy your first home at any time before you’re 60. You can also withdraw from your Lifetime ISA if you’re terminally ill and have less than 12 months to live. If you withdraw for any other reason, you’ll be charged a 25% government penalty on the amount you take out.

If you plan to use the Lifetime ISA to buy your first home rather than to save for retirement, there are a few important rules to bear in mind, particularly that you have to:

• be a first-time buyer and not own property anywhere in the world
• live in the house you’re buying
• buy the home for £450,000 or less.

The Help to Buy ISA

The Help to Buy ISA is a type of cash ISA. It’s a government scheme to help first-time homebuyers save for a mortgage deposit to buy a home. To qualify, you must be a first-time buyer and not own property anywhere in the world. The Help to Buy ISA closed to new accounts at midnight on 30 November 2019.

Your first payment to your Help to Buy ISA can be up to £1,200, and after that you can contribute up to £200 each month. The government will top up any contributions you make by 25%, up to the maximum contribution limit of £12,000. This means you can get a total of £3,000 from the government.

What’s more, if you’re planning to buy a home with someone else, you can each open a Help to Buy ISA – meaning that you could get up to £6,000 from the government to put towards your first home.

Help to Buy ISAs can be used for homes costing up to £450,000 in London and £250,000 outside London. If you’d like to buy a property outside London for more than £250,000, the Lifetime ISA might be a better option for you.

The Innovative Finance ISA

The Innovative Finance ISA is a peer-to-peer (P2P) investment wrapped up in an ISA. So you’re able to invest in peer-to-peer lending platforms without paying capital gains tax on your returns.

If you invest in P2P lending you may get a better interest rate than through a high street bank savings account. But the risks are greater, too. If the ‘peer’ you lend to doesn’t perform as expected, you could bear the brunt of any losses, and those losses are final if they default on a payment.

Liquidity can also be an issue if you want to withdraw your money before the end of the term of the loans you’ve made.

Innovative Finance ISAs aren’t currently backed by the Financial Services Compensation Scheme (FSCS), so you may want to approach these ISAs with caution.

The Junior ISA (JISA)

A Junior ISA is a way to start building up savings for children as early as possible. All children resident in the UK can have one. A parent or legal guardian can open it on the child’s behalf; 16-year-olds can open a Junior ISA for themselves. Anyone, including grandparents, aunts and uncles can add money to a Junior ISA (However, at Nutmeg only the registered contact can contribute.) Once the child turns 18, the Junior ISA automatically converts to an adult ISA.

You can transfer an existing child trust fund (CTF), for which investments are made in cash, into a Junior ISA. As with their adult counterparts, Junior ISAs are tax efficient. You can open a Junior stocks and shares ISA or a Junior cash ISA.

The Junior ISA allowance for the current tax year is £9,000.

What is ISA flexibility?

ISA flexibility refers to whether you’re able to withdraw from your ISA without affecting your annual allowance. If an ISA is flexible, you can withdraw money from it and then put money back into it, within the same tax year, without affecting your annual ISA allowance. It applies to money deposited in the ISA in previous years as well as money you’ve contributed in the current tax year.

Let’s look at an example:

You have £35,000 in a flexible cash ISA. This is made up of £25,000 from previous tax years and £10,000 that you’ve contributed during this tax year. The current ISA allowance is £20,000 per tax year, which means you still have £10,000 of your allowance remaining. You decide to withdraw £15,000. Because it’s a flexible ISA, you’re still able to contribute a further £25,000 in the current tax year – this is made up of the £15,000 you took out and the £10,000 remaining of your annual year allowance.

If an ISA is not flexible it means that if you withdraw money, that part of your annual allowance remains used. So, if you had already reached the ISA allowance limit and then decided to take money out, you would not be able to put the money back into an ISA within that tax year.

Flexible ISAs are normally cash ISAs, but not all providers offer flexible cash ISAs. However, cash ISAs are not the only ISA types that offer flexibility – depending on the provider, you may be able to get flexibility within an Innovative Finance ISA and for the cash held within a stocks and shares ISA. Flexibility is not available for Lifetime ISAs and Junior ISAs. Make sure you check with your provider to ensure your ISA meets your needs. Nutmeg does not offer flexible ISAs.

Who can open an ISA?

To open an ISA, you have to be a UK resident for tax purposes. You can only open an ISA for yourself and not with, or on behalf, of someone else - except in the case of a Junior ISA.

Specific ISAs have different restrictions in terms of how old you need to be to open one. You have to be:

• 18 or older to open cash ISA
• 18 or older to open a stocks and shares ISA or an Innovative Finance ISA
• between 18 and 39 years old to open a Lifetime ISA
• between 16 and 17 years old to open a Junior ISA for yourself
• 18 or older to open a Junior ISA for a child, assuming you’re the child’s parent or legal guardian.

What is the difference between an ISA and a savings account?

There are a few differences between an ISA and a savings account that are worth knowing.

The biggest differences between a regular savings account and an ISA are:

• Savings accounts generally don’t have an annual contribution limit, whereas ISAs have a government-specified annual allowance.
• With regular savings accounts, you save your money as cash; if you open an ISA, you can choose to save in cash, invest in stocks and shares, or invest in peer-to-peer lending.
• Depending on your personal circ*mstances and income tax rate, you’ll have to pay tax on any interest earned in a savings account that is over your personal savings allowance. For an ISA, you never pay tax on any growth, returns or interest earned. The interest earned in an ISA doesn't count towards your personal savings allowance.
• When you die, ISA allowances can be passed on to your spouse or civil partner more tax efficiently than money in a regular savings account.

There are also some similarities between ISAs and savings accounts. For example, both have account types that allow you to access your money easily without paying a penalty fee, and both have account types where you can put your money into the account for a fixed amount of time at a certain interest rate.

Whether you choose an ISA or a regular savings account, the choices you make around where and how to invest or save money will depend on your personal circ*mstances, goals, the length of time you want to put your money away for and the level of risk you are willing to take with that money.

How many ISAs can you have?

You can open and contribute to as many stocks and shares ISAs, cash ISAsor Innovative Finance ISAsin any one tax year as you like. However, you may only open and contribute to one Junior ISA or Lifetime ISA per tax year.

It’s important to remember that while you can have both a Lifetime ISA and a Help to Buy ISA, you can only use the government bonus from one of them to buy your first home. However, you could use the Help to Buy ISA to purchase your first home and then use the Lifetime ISA for retirement - receiving the government bonuses from both schemes.

You can decide how to use your annual ISA allowance across the different ISA types you’re eligible for. However, it's worth remembering that if you choose to contribute to multiple ISAs in a tax year, you'll need to make sure you don't exceed your £20,000 overall annual allowance.

The maximum you can contribute to a Lifetime ISA is £4,000each tax year, and this is included in your overall £20,000 limit – so if you contribute £4,000 to your Lifetime ISA, you have £16,000 left to contribute to other types of ISAs during the tax year.

A child can have one cash JISA and one stocks and shares JISA, opened by a parent or guardian.Each child has a £9,000 per year JISA limit, which is separate to the parent/guardian's £20,000 allowance. Once a parent or guardian has opened a JISA for their child, anyone can contribute to it - up to the annual limit.

Let’s look at an example:

Let’s say you already have a stocks and shares ISA, a Lifetime ISA, and a cash ISA.

You haven’t yet used any of your £20,000 annual ISA allowance for the current tax year.

You contribute £11,000 into a stocks and shares ISA and £4,000 into your Lifetime ISA. You’d still have £5,000 to use across the tax year. You could use your remaining allowance to pay into multiple cash ISAs or additional stocks and shares ISAs, in any combination you like - as long as you don't exceed the £20,000 limit.

You can also contribute to someone else’s Junior ISA without affecting your annual allowance.

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek financial advice.