Pick the right Isa and shield yourself from income, capital gains and dividend taxes
First launched in 1999, Isas – more formally known as individual savings accounts – have become a hugely popular way for savers and investors alike to protect their money from tax.
That’s because savings interest and investment returns earned from money held in an Isa is tax-free, shielding you from potential income tax, capital gains tax and dividend tax charges.
But there are several rules you’ll need to abide by to keep this tax-free status. For instance, all adults in Britain get an Isa allowance of £20,000 – this is how much you can deposit into Isa accounts during each tax year.
Here, Telegraph Money takes a look at the different types of Isas to help you decide which options could work for you. In this guide we will cover:
An Isa is a tax-efficient account for savings or investments. They are well-suited to people wanting to put away up to £20,000 a year and keep their tax bill to a minimum, since all growth within an Isa is tax-free.
There are four main types for adults:
Most people can open an Isa, though you usually need to be 18 to open an account for yourself.
You also need to be either resident in the UK, or a member of the armed forces, a Crown servant or their spouse or civil partner if you live abroad.
Isas can’t be held as joint accounts, but you can open one for a child if you’re their parent or guardian.
Previously, you could only pay into one type of Isa per year, but that changed on April 6, 2024. You can now open and pay into as many as you like, provided the total amount you deposit into all of your Isas doesn’t exceed £20,000.
You can save up to £20,000 across all Isas in each tax year. You might choose to put the whole sum into one cash Isa, for example, or split it between several different accounts.
You can only place up to £4,000 a year into a lifetime Isa, and this contributes towards the total £20,000 sum. So, if you were to save £4,000 in a lifetime Isa, you’d have £16,000 left to save with another type of account.
From April 2027, savers under 65 will only be able to deposit up to £12,000 into a cash Isa. The remaining £8,000 of their allowance would need to be used in an investment Isa. There is no change for over-65s.
All four types of Isas offer tax-free returns, but they each have their own pros and cons – and some come with extra rules.
It’s important to choose the right Isa, or Isas, to suit how you want to save or invest, and which fit your saving goals.
Cash Isas are offered by banks, building societies and National Savings and Investments (NS&I).
They function in pretty much the same way as normal savings accounts – the main differences being the restrictions on how much you can pay in, the penalties for withdrawal and how you switch to a different one.
There are three main types of cash Isas:
Before the rules changed in April 2024, you could only pay into one cash Isa per year, and had to make an Isa transfer if you wanted to take advantage of a better offer elsewhere. Now, you can simply open and pay into the new account – but if you want to move the money you’ve already deposited you’d still need to get it transferred.
You can find the best cash Isa rates in our guide, which features tables that are updated daily.
A stocks and shares Isa can hold a range of investment products.
These include unit trusts, investment trusts, exchange-traded funds, individual stocks and shares, corporate and government bonds, and Open Ended Investment Companies (OEICs).
Lots of banks offer stocks and shares Isas, as do a host of investment platforms. You might decide to get one that’s managed for you, or you can do it yourself.
Investment returns can produce higher returns than cash, but this isn’t guaranteed and will depend on the performance of the investments held in the account.
If you’re thinking about investing, it’s good to go in with a long-term view in mind – ideally, you’ll be looking to invest for at least five years. This gives investments time to grow, and will hopefully even out any short-term volatility.
As with cash Isas, it’s possible to transfer funds from current or previous tax years to a new account, and you have to fill out a transfer request form to do so.
This relatively niche type of Isa allows you to invest in loans given to consumers and small businesses. Also known as the “peer-to-peer” Isa, you lend your money to borrowers in return for a set amount of interest based on the length of time you are prepared to lock it away for.
You can choose to invest your full £20,000 allowance into an Innovative Finance Isa each year. However, fewer providers offer these Isas than other types, and each one differs in the rates they offer, who they lend to and how they structure the investments. Make sure to read up on what you’re investing in before you go ahead and part with your cash.
Experts have warned that some Innovative Finance Isas pay little more than cash accounts, despite the higher risks involved.
Most providers have a back-up fund that will pay out if borrowers default on their loan repayments. However, if a large number of borrowers were to default at the same time then providers may struggle to pay out, and could even go bust.
If the worst should happen, money held within an Innovative Finance Isa is not protected under the Financial Services Compensation Scheme (FSCS), so you could stand to lose your savings.
Lifetime Isas (Lisas) were introduced in 2017 to help people either save up to buy their first home, or for retirement savings. They have now replaced the Help to Buy Isa that was scrapped in 2019.
They can be opened by those aged 18 to 39, and you can deposit up to £4,000 a year – anything you pay in will count towards your £20,000 Isa allowance. You can choose between cash or stocks and shares Lisas.
The biggest bonus Lisas offer is that the Government tops up your savings with an extra 25pc, which means you could get up to £1,000 extra each year.
However, you can only keep saving into the account until you turn 50. If you’re saving for retirement, you’ll then have to wait until you turn 60 before you can access your savings – but they can then be spent however you choose. The Government top-ups also stop when you turn 50, but your Lisa still attracts interest until you access it.
Our guide to the best Lifetime Isa providers shows the best cash Lisa rates, and outlines the best stocks and shares Lisa providers, too.
While these accounts are still available for new savers, the Government intends to launch a new type of accounts for first-time buyers from 2028, with details yet to be released.
You’re free to hold all types of Isas, and you can pay into as many as you like – but when selecting an Isa, it’s crucial to have a clear idea of what you’re trying to achieve.
Jason Hollands, of investment company Bestinvest, said: “Key considerations are what types of Isa to open and, alongside this, what to hold in it – cash savings or investments.
“My key tip here is to spend a little time considering your goals before rushing in to make a choice. If you know that saving for a first property purchase is your main goal, and you are under 40, then a Lisa could be a great option.
“Whether to use an Isa for cashing savings or investing in many ways comes down to the time horizon of your goals. Isas can be used for a myriad of goals, including paying off a mortgage, covering future education fees, a holiday of a lifetime or retirement.
“It is very wise to have some cash savings set aside for rainy days and emergencies, but holding a huge cash war chest that you won’t need to touch for many years risks seeing the real value slowly eaten away by inflation. Those with longer term horizons, who already have sufficient cash for shorter term needs and emergencies, should therefore focus on investments.”
You don’t pay tax on your money’s growth when it’s held in an Isa. It’s shielded from income tax, dividend and capital gains tax. It doesn’t matter how much you make or how many Isas you have, provided you haven’t deposited more than £20,000 in each tax year.
Some savings accounts can offer better interest rates than Isas, but as savings interest is taxable you might find yourself being hit with an unexpected bill if you exceed your tax-free personal savings allowance.
Here’s an example of the tax you might pay on a savings account:
Use our savings tax calculator to see how much you’d pay if your cash was held in a savings account, so you can decide whether it’s worth switching to a cash Isa instead.
From April 2027, you’ll pay more tax on savings interest, with a 2 percentage point increase being applied to all tax bands.
You’ll have to consider the trade-off between how much tax you could save with an Isa, compared to the extra interest you could earn with a savings account.
Used smartly, and over several years, an Isa could be the key to becoming a millionaire.
For cash Isas, it’s important to shop around for the best rate – but you’ll need to consider when and how often you need to access your money, or how long you can afford to lock it away for.
You should also look carefully at any transfer fees, in case you see a different Isa with a better rate and want to switch.
Claire Trott, of St James’s Place, said: “Cash Isas allow you to earn tax-free interest on your money and are conveniently flexible, offering simple access to your cash if you hit an unexpected expense.
“While it’s key to put as much into your Isas as you feel comfortable with on a regular basis, you want to be sure that any Isas you do have are getting good rates and earning their keep. Ensuring you monitor your mix of cash and stocks and shares Isas over the whole tax year can help make the most of your money.”
If you do opt for a stocks and shares Isa, it’s more complex. Experts say you should be willing and able to play the long game.
Mr Hollands said: “Investing should be considered as a long-term game of at least five years, as the value of investments can fluctuate up and down. In a nutshell, investing and holding on for the long term is more important than trying to guess whether markets are about to go up or down in the short term.
“For those who are worried about the short-term ups and downs of financial markets, one way to overcome this is to invest on a regular, monthly basis via direct debit. Over a year, this will smooth out some of the short-term gyrations in the markets, and it is also a great discipline that keeps you steadily investing when the headlines are both cheerful or gloomy.”
Ms Trott added: “If you have a stocks and shares Isa, it can make sense to drip feed payments into your account over the year, rather than making one big payment just before tax year-end. That way, you flatten out the natural rises and falls in the stock market and share values, rather than making a big payment on a day when the market happens to be lower.”
If you’ve decided to open an Isa where you manage your own investments, the money it earns will be tax-free regardless of how much that is. However, you’ll need to actively manage it and decide how to split your investments across different assets, such as equities, bonds, gold and property, and across various regions and geographic sectors. This is called “asset allocation”.
The value of these investments can go up and down, so it’s crucial to keep monitoring them.
Mr Hollands said: “Even a well-planned Isa portfolio, with a carefully designed ‘asset allocation’, will naturally drift over time as different types of investments will not all move neatly in tandem. Left untended, a medium risk portfolio could gradually morph into a very high risk one.
“If you are going to manage your own Isa investment portfolio rather than choose a managed one, it is important to periodically review it and potentially rebalance it so that it continues to reflect the appropriate level of risk to suit your goals and appetite. And, of course, your circumstances and goals may change over time.
“As your time horizon narrows, with your financial goal coming into sight, this may require a change in approach to a less risky one.”
Even if you have a cash Isa, or a stocks and shares Isa that’s managed for you, it’s still important to make sure it’s still working for you. Considerations such as the level of interest or returns it pays, how much you can afford to put in and if or when you’ll need to access the money should all be factors in this.
It’s usually very easy to open an Isa. Depending on the type, and provider, you may be able to do the whole process online or via an app.
You’ll need to provide a few personal details, and you’ll usually be asked to provide proof of identity and proof of address in some way.
Isas can only be opened by those who are UK residents for tax purposes. If you move away, you must inform your Isa provider – you’ll usually be able to keep the account open, but you may not be able to add money to it while you’re living abroad.
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