An individual savings account, commonly known as an ISA, is a type of account that offers tax-free interest payments on your savings.
Like a regular savings account, you can use a cash ISA to save for short-term goals like a special holiday or to keep your money safe for a rainy day.
But the main difference between a cash ISA and a savings account is the tax you pay.
With a cash ISA, you won’t ever have to pay tax on the interest you earn. Although there are limits on how much you can deposit into one in each tax year.
You can open a cash ISA through various lenders including banks, building societies and some national savings and investment providers.
You can only open and put money into one cash ISA each tax year, which runs from 6 April to 5 April the following year.
There’s also a limit on the amount of money you can pay into an ISA each tax year, which is set by the government. This deposit limit is currently £20,000.
Most importantly, any cash you put into an ISA stays tax-free for as long as it’s in there.
There are several benefits to opening a cash ISA:
It’s easy and straightforward to open an ISA.
You’ll need to provide some proof of identity and your address. There may be a minimum deposit amount to open the account, but not always.
You can open most cash ISAs online, over the phone or by going into your local branch.
Remember that rates on cash ISAs can vary so it’s worth shopping around and comparing options first.
You’ll have a set tax-free amount you can save each year - this is called your ISA allowance.
For a cash ISA, this allowance means you can pay in up to £20,000 each tax year.
When each financial year starts your tax allowance is reset and any you didn’t use the previous year will be lost.
So, if you paid in £7,000 one year, you can’t carry over the remaining £13,000 tax-free allowance to the following year.
Some cash ISAs are flexible and let you withdraw money from your account and then replace it in the same tax year, without going over your ISA limit.
The main types of cash ISA are:
Easy access cash ISAs - Also known as instant-access cash ISAs, this will let you withdraw money without paying a penalty. They usually come with variable interest rates, which means the rate can go up as well as down
Fixed-rate cash ISAs - Offering a fixed rate of interest over a set period, this type of ISA requires you to commit to locking your money away in return for a potentially higher interest rate. But you’ll usually be charged if you want to withdraw your money early
Regular saver cash ISAs - This type of ISA usually pays a higher rate of interest that’s fixed, if you put away a regular amount each month for a set time. Generally, there’s a minimum and maximum amount that you can deposit each month
Lifetime cash ISAs - This is a product designed by the government to help people under 40 save for their first home or for retirement. You can deposit up to £4,000 each year and the government will add a 25% bonus on top of your savings. It has a fixed rate of interest
Some lenders will also allow you to split your money between a variable rate and a fixed-rate cash ISA in the same tax year, using what’s called a single cash ISA portfolio. So, you’ll still only be able to deposit £20,000 per year, but it can be spread between different products.
To be eligible to open and use a cash ISA you need to be:
If you want to open an ISA for a child who is under 18 you can get a Junior ISA - these have a smaller ISA annual allowance of £9,000.
Some ISAs are designed for you to be able to withdraw money when you need it, like the instant-access cash ISA.
With a fixed-term cash ISA, you’ll deposit your money during the term and once it has finished you can withdraw it or switch to a new ISA.
But if you withdraw the money before the end of the fixed term, you’re likely to be charged, which could be a whole year’s worth of interest.
The good news is that when you withdraw money from your cash ISA, you won’t need to pay income tax or capital gains tax.
Yes, it’s possible to transfer your savings to a new ISA provider and this can be a good way to get a better interest rate.
To transfer your ISA, it’s important not to withdraw the money first.
If you do this, you’ll lose the long-term tax benefits and have less tax-free allowance to use in that year.
Some providers charge a fee to transfer, especially if you want to transfer before the end of a fixed term, so you should check if it’s worth it before you make a move.
It’s worth noting that if you want to transfer from a lifetime ISA to a different type of ISA before the age of 60, you’ll have to pay 25% in charges.
Yes, you can transfer your money between all types of ISA and you can choose to transfer some or all of your ISA balance.
If you’ve got more than one ISA, you can also combine them into one new ISA.
You’ll need to use an ISA transfer service to make the switch. This prevents the money you’ve saved in previous tax years from counting towards your current tax-free allowance.
For example, you could transfer £12,000 of your ‘old’ cash ISA savings into a new stocks and shares ISA and still add up to £20,000 more in that tax year.
Typically, you can only open and pay into an ISA if you’re a resident in the UK.
If you open an ISA and then move abroad, you won’t be able to pay money into it or open a new ISA after the tax year that you move (unless you’re a Crown employee working overseas or their spouse).
You’ll need to tell your ISA provider you’ve moved as soon as you stop being a UK resident. But you’ll still be able to hold onto your existing ISAs and benefit from their tax-free status.
If your spouse or civil partner passes away, you should be able to inherit their ISA savings through what’s called an inherited ISA allowance.
This means that as well as your normal ISA allowance, you can add a tax-free amount up to either the value of the inherited ISA when they died or the value when it was closed.
If you’ve inherited an ISA from someone who isn’t your spouse or civil partner, the cash ISA will form part of that person’s estate and the usual inheritance tax rules will apply.
If you’re not sure whether cash ISAs are the right option for you, there are several other alternatives you can consider.
For example, you could use a stocks and shares ISA which invests your savings in the stock market. But it’s important to understand the value of your investment can go down as well as up, so you may not get back what you put in.
Standard savings accounts are another option. Under the personal savings allowance, basic-rate taxpayers can earn the first £1,000 of interest on savings tax-free. The allowance is £500 for higher-rate taxpayers.
Interest paying current accounts can provide better rates than variable-rate cash ISAs and regular savings accounts. Although there’s a cap on the amount you can save (usually between £5,000 to £20,000), which limits the amount of interest you can earn.
An alternative for your savings is to use premium bonds. These don’t provide interest but offer the potential for your money to increase by being entered into a monthly cash prize draw. And there’s no risk that the value of your investment will drop.