By understanding the core differences between savings accounts and ISAs, you can make an informed decision as to where to put your money, based on your financial goals.
Savings Accounts and ISAs
In the world of finance there are a lot of niche terms and acronyms, so it’s no wonder that money can be confusing. When it comes to savings, there are two key types of accounts to know about: a savings account and an ISA.
In this article, we’re breaking down the difference between the two so that you can decide whether an ISA or a savings account will best help you reach your financial goals.
What is an ISA?
An ISA, which stands for Individual Savings Account, is a type of savings account which guarantees that you never pay any tax on the money in the account (within the threshold). In the UK, each tax year everyone has an ISA allowance (for the tax year 2020/2021 it is set at £20,000) which can be split across different types of ISA. When the new tax year starts, your ISA allowance begins and you can save or invest another £20,000 (or the allowance available that year) through ISAs.
There are several types of ISA, the main types being:
- Cash ISA: A cash ISA is a savings account which allows you to deposit and withdraw money up to the full ISA allowance. You can choose either an instant access cash ISA or a fixed term cash ISA, where your funds will not be accessible until the end of the term.
- Stocks & Shares ISA: These are tax efficient investment accounts, using your £20,000 annual ISA allowance to earn tax-free returns when you invest in stocks and shares.
- Lifetime ISA: Lifetime ISAs are government-backed savings accounts which help you to save towards your first home or towards retirement. When you save money into a LISA, the government will top up your account with a 25% bonus, up to a total of £1,000. You can withdraw money from a LISA as a deposit if you’re a first-time buyer, or for your retirement when you reach 60.
There is also an innovative finance ISA which allows peer to peer lending within a tax-free wrapper, as well as Junior ISAs which are specifically designed for children.
Should I choose an ISA or a savings account?
Both regular savings accounts and ISAs can help you to build your wealth and maximise the money that you have. Whether or not to put your money in an ISA or a savings account, however, depends on a few factors, including your individual financial goals in the short, medium and long term.
If you’re an aspiring first-time buyer, the 25% LISA government bonus is a major bonus and often it’s worthwhile to save the £4,000 annual limit into a LISA so that you can get the full £1,000 bonus.
For those who aren’t first time buyers, consider whether a Cash ISA or savings account will provide the best returns. Each savings account or cash ISA will have an interest rate, which determines how much interest you will earn on your savings. Especially if you have significant savings, the interest rate can make a huge difference to your savings, so pay attention to the best rates in the market when deciding which type of account to choose.
Although interest on a savings account is taxable, the Personal Savings Allowance allows you to earn up to £1000 of interest tax free if you are a basic rate taxpayer, and £500 if you are a higher rate taxpayer. Given the current interest rates, the amount of savings required to hit the threshold is very high, it can be worthwhile looking at Cash ISAs and savings accounts to find the best rate.
If you’re looking to make your money work for you in the long term, a stocks and shares ISA may be a good starting point. When you invest your money, the value of your investments can decrease as well as increase, however investing can offer a way to build significant wealth over the long term.
Key takeaways
- Whether to use an ISA or a savings account will depend on your individual financial goals.
- There are three main types of ISA: Cash ISA, Stocks and Shares ISA and a Lifetime ISA.
- Wherever you decide to put your money, both saving and investing can help build your wealth.
