If you could, would you stop paying tax? Sounds a bit too good to be true, doesn’t it? Well, with savings, you can. Saving or investing through an ISA means you don’t pay income or capital gains tax on the interest you earn, whether you’re a basic taxpayer or pay tax at a higher rate. Without an ISA, you lose 20% and 40% respectively on your earnings, and with interest rates at their lowest in the 322 years of the bank’s history, this can turn small returns into miniscule ones. For example, 1% interest can be turned into just 0.8% by basic tax, or 0.6% by higher rate tax. Over the course of a year, saving outside of an ISA would lose you £40 (or £80 for higher rate taxpayers) on a £10,000 savings pot, and when you’re only earning £100 on £10,000, losing any of your returns can be damaging.
So saving through an ISA makes sense, right? In theory, yes, but our research suggests that the UK may not be making the most of the tax-free savings allowances that are on offer. The 2017 Momentum Financial Wellness Index revealed that 76% of the UK currently have more than £100 in savings right now. However, just one in five people have those savings held in an ISA of some kind.
There are a few rules surrounding individual savings accounts (ISAs), which can make them seem more complicated than they are. Firstly, there’s a limit to how much you can put in your ISA every tax year, which is April to April. For this year it’s £15,240, and the deadline for using it up is midnight on the 5th April (any unused allowance won’t roll over into the next tax year).
Whereas previous ISA rules meant that you could only save half of your ISA allowance in a cash ISA, and the rest in a stocks and shares ISA, you can now split your savings as you choose between a cash ISA, stocks and shares ISA, and a new ‘innovative finance’ ISA (through which you can invest using peer-to-peer lenders without paying tax on your earnings).
Should I split my ISA allowance? And which ISA is right for me?
How (and, indeed, whether) you choose to split your allowance across the three main types of ISA will depend entirely on your personal goals, and what you want to achieve with your savings.
A cash ISA offers a low-risk, easy-access option, but don’t expect returns to be groundbreaking (the average cash ISA is currently offering an interest rate of just 0.82%). For (potentially) better returns, you may want to consider a stocks and shares ISA - a form of investment account which allows you to put your money into different types of investment (you can read more about them in our guide to stocks and shares ISAs). Unlike a cash ISA, money in a stocks and shares ISA can go up as well as down, so it’s generally advised that you should only put your cash into one if you’re able to leave it in there long enough to ride the ups and downs. If you can, you may see better returns. An innovative finance ISA is also a form of investment, through which you can invest with peer-to-peer lenders, which are lending sites which match borrowers and investors.
However you decide to use your allowance, an ISA is generally a no-brainer, allowing you to save or invest any cash you’ve saved without losing out due to tax.