Isas: Everything you need to know

It is Isa season – the best chance to snap up a tax-exempt savings deal. But how do you work out which one to go for? Funny you should ask…

Average weekly household spending in London and the South East was over £600 (Getty/iStock)

There’s an awful lot of fuss about saving and investing at this time of year.

On the countdown to the end of the tax year, all of a sudden the adverts become more prominent and everyone, it seems, is telling you that you need an Isa.

And yet millions of us don’t bother shielding our hard-earned cash from the tax man because we think it’s too complicated, that they don’t have enough money to take advantage or that having one would mean completing a tax return.

None of these things are true.

Back in 2015, many of the restrictions were simply done away with. Instead of restricting how much of your allowance could be saved into cash or investments, it is up to you how much of your money you wish to save into what kind of pot – cash or investments.

And while the amount that could be saved or invested was previously limited to a few thousand a year, it’s now been raised to £20,000 – unless you are choosing to save into a lifetime Isa or Help To Buy Isa.

That said, there are now even more options. What’s more, some of them are more complicated than a straight-up bank account. But they also cater for more situations than ever before and let you save or invest more than ever before too.

So here’s a quick rundown of the options available to you. Pay attention, because this could really pay dividends. Literally.

Cash Isa

This is the most straightforward of all the Isa options and it is certainly the most popular. A cash Isa is very simply a savings account where the returns earned can never be touched by the tax office.

It’s possible to choose from among a variety of types, just as with a standard savings account. There are instant access accounts, regular savers, fixed term bonds – the only difference is that with a cash Isa you can’t open more than one a year.

Stocks and shares Isa

This is the second of the “original” Isas and it’s sometimes referred to as an equity or investment Isa.

It allows account holders to invest in funds, bonds and shares, and to keep any returns entirely without having to pay tax.

You will usually invest via a broker or fund supermarket and it’s normal to pay a fee for the privilege of doing so.

Generally speaking, over time, stocks and shares Isas outperform cash savings. However, investments can go down in value as well as up, so it’s considered riskier than saving into a cash account.

Innovative finance Isa

Many people prefer to invest their money into peer-to-peer lending or crowdfunding opportunities, particularly with interest rates on savings so persistently low. This allows you to lend individuals or companies money and earn interest by doing so.

The innovative finance Isa was designed to allow such investors to also take advantage of tax-free returns.

Only a handful of companies currently offer innovative finance Isas and most are existing peer-to-peer lenders, however, there are growing numbers of specialist innovative finance accounts. Of course, if the borrower doesn’t repay the money then you risk making a loss but the most reputable providers spread customers’ money across multiple loans and some provide a back-up fund.

Help To Buy Isas

At the end of 2015 the government launched a new kind of Isa designed solely for first-time buyers and with an impressive bonus. Savers could add up to £1,200 when they first opened the account and then £200 a month after that. The government agrees to pay a 25 per cent bonus when you use the money to buy your first home, up to a maximum of £3,000.

Unlike normal cash Isas, the amount you can save is capped far below the £20,000 allowance. However, a few providers let you save the remainder of your Isa allowance into a separate cash account if you want to do so, or you could choose to invest it in stocks and shares or finance if you have extra you want to put away.

Lifetime Isa

Less than two years after the HTB Isa, the Lifetime Isa (Lisa) was launched. Once again, the government will pay a 25 per cent bonus on your savings or investments, but with this account you can keep earning the bonus until you reach 50. Because the bonus is paid monthly, you’ll even earn interest on it.

However, there are real restrictions on what you can do with the cash. If you don’t withdraw it to pay for your first home then the money cannot be touched until you reach 60 unless you’re prepared to pay a penalty.

That penalty is 25 per cent, which means that you would lose more than the bonus paid as the penalty is applied to the full amount in the account. In short, unless you’re planning to save for a first home or a decent retirement, this is probably not the right account for you.

Hang on, should I have a HTB Isa or a Lisa?

More than a million people have taken out a Help To Buy Isa since they were launched in December 2015 and during that time around £104m has been paid out in bonuses.

However, when Lifetime Isas were launched last year, also offering a bonus, it became less clear which was best for would-be home buyers.

Sarah Coles, personal finance analyst at Hargreaves Lansdown, says: “The good news is that the decision is fairly straightforward: if you have at least a year until you plan to buy your first home, and you are aged between 18 and 39, the Lifetime Isa is usually better.”

That’s because the LISA offers a bigger bonus. HTB savers can save up to £3,400 in the first year and £2,400 after that. There’s also a cap of £3,000 on the amount of government bonus that can be paid, whereas the Lisa allows contributions of up to £4,000 a year until the account holder reaches 50 – meaning a far higher maximum bonus of £32,000.

Whether you’re saving an emergency fund, saving for a long-term goal (for retirement or for a home), or whether you’re seeking to invest and beat low savings returns, it’s possible to keep your money clear of the tax office with an Isa account.