Types of ISA explained

The term ‘ISA’ is one that many people are familiar with but might not be too sure of the true benefits that using this allowance can bring. 

An Individual Savings Account (ISA) is a tax-efficient savings vehicle, and there are many benefits to each type of ISA that you can hold. The main types of ISA include a Cash ISA, Stocks and Shares ISA, Lifetime ISA (LISA) and Junior ISA (JISA). It is important to know who can hold each type of ISA, and also how these ISAs can contribute to your financial planning needs. If you are at a point in your life where you are ready to take the first step on your investment journey, then an ISA can be a good place to start due to the valuable benefits available. This article will explain the key differences and how each type of ISA could help you to meet your financial goals. 

Individuals have an annual ISA allowance that is currently £20,000 per tax year (6th April – 5th April), and this allowance cannot be carried forward if unused – so it’s a case of use it or lose it! You can hold up to four different types of ISA in any given tax year, including a Cash ISA, Stocks and Shares ISA, Innovative Finance ISA and a Lifetime ISA – but the total cannot exceed the annual allowance. So, if you put £4,000 into a Lifetime ISA, you can share the remaining £16,000 between the other types, or put some or all of the remaining allowance into just one type. 

Cash ISA

A Cash ISA is an ISA wrapper for cash holdings. Cash ISAs are in addition to the Personal Savings Allowance. For reference, all basic rate taxpayers have a £1,000 Personal Savings Allowance, whereby you can earn interest up to £1,000 per year, tax free. Higher rate taxpayers have a Personal Savings Allowance of £500 and additional rate taxpayers do not benefit from the Personal Savings Allowance at all, therefore making the tax-free environment of an ISA more advantageous. 

To open a Cash ISA, you must be over 16 years of age, and a UK resident. Cash ISAs are effectively very similar to a standard bank account, but the key difference is that any interest earned from a Cash ISA is tax-free. There are different types of Cash ISA available to you. A fixed rate Cash ISA for example will offer a fixed rate of interest for a specific term and accessing your funds prior to maturity could result in a penalty. A variable rate Cash ISA is the most flexible, as you can put capital in and take capital out as and when required, although notice may need to be given if it is not an easy access cash ISA. 

It is important to consider how much flexibility you need with your finances, how long you are willing to be restricted from your accessing your money and any penalties that could apply. 

A Cash ISA is an attractive savings vehicle for those who are likely to exceed their Personal Savings Allowance. 

Stocks and Shares ISA

A Stocks and Shares ISA involves investing your money in the financial markets within a tax-free wrapper. A Stocks and Shares ISA is an invaluable starting point for those looking to branch away from cash holdings and gain access to the potential for higher returns than you could achieve from cash deposits. You must be comfortable taking a degree of investment risk, as although you are investing for greater returns, this cannot be guaranteed once you begin to invest your capital as ultimately the value of your ISA will depend on the performance of the underlying investments.

A Stocks and Shares ISA is a tax-efficient investment account whereby you can invest capital into a range of different investments. All income and growth within a Stocks and Shares ISA is tax-free, and should you wish to withdraw money from your ISA any capital gain will also be free of tax, so it could be a tax efficient way to produce a regular income. As the level of risk and the underlying investment strategy is key when choosing a Stocks and Shares ISA, it’s important to use an investment  platform that can provide a comprehensive investment strategy suitable for your risk appetite. 

Lifetime ISA (LISA)

Lifetime ISAs are a more recent addition to the ISA stable and are only available to open to those aged between 18 and 39. However, the benefits are multi-faceted. While, as mentioned above any UK resident between the ages of 18 and 39 can open a LISA, you can contribute up to your 50th birthday. A LISA has a dual purpose; either to help fund the purchase of your first home, or you can use your LISA any time after the age of 60 to subsidise your retirement income. 

You can put a maximum of £4,000 per annum into a LISA (current allowance), and this would count towards your overall £20,000 per annum ISA allowance. 

The primary benefit of holding a LISA is the 25% government bonus that is added to each deposit made, up to the maximum allowance. For example, paying in the full £4,000 would result in a £1,000 immediate uplift, to £5,000. The bonus is added at the end of the month following your contribution. 

In terms of the underlying holdings, you can invest in a Cash LISA or a Stocks and Shares LISA, or indeed a combination of both provided the contributions are made in different tax years. Of course, as with any investment holding, it is important to consider time horizons. If you are planning to use your LISA to purchase your first home within the next 3 to 5 years, then it would be prudent to remain in cash deposits to prevent having to release your funds during a period of market downturn and it should be noted that you must hold the account for a minimum of 12 months from the date of the first deposit otherwise there may be a penalty to pay on any withdrawal.

Alternatively, if you wish to use your LISA to accumulate a savings pot for retirement, then the longer-term time horizon will likely be conducive to greater opportunity for return within an investment portfolio. 

All growth within your LISA is tax free, as are any withdrawals you make after your 60th birthday or earlier if used for first time property purchase. If you access your LISA prior to your 60th birthday, and the funds are not used to purchase a first-time property, then you will be subject to a 25% withdrawal charge. 

Junior ISA (JISA)

A Junior ISA can be opened by any parent or guardian on behalf of their child. Once a parent or guardian has opened the JISA, anyone can contribute to the account up to annual subscription limit, which is currently set to £9,000 for the 21/22 tax year.

A parent or guardian will control the JISA on behalf of the child until they are 16 years old, and at that point the child can manage the account but cannot make withdrawals until their 18th birthday. Young adults aged 16 and 17 can open an adult Cash ISA and continue to hold their JISA until age 18, meaning that they can benefit from both ISA allowances during this period of time (£20,000 ISA subscription and £9,000 JISA subscription).
A JISA can be held as a Junior Cash ISA or a Junior Stocks and Shares ISA, and all growth within the JISA is entirely free of tax. A JISA can be opened for a UK resident child under the age 18 who does not have a Child Trust Fund (CTF) account. 

As you can begin to accumulate funds for your child from birth and maximise the compounded growth that can be achieved until their 18th birthday, a JISA could ensure your child is in a financially advantageous position when entering adulthood. 

Be that to fund University fees, travelling opportunities or simply remaining invested within an adult ISA for them to continue to learn the value of saving for the future. 

Conclusion

In conclusion, an ISA is a tax efficient way to save money from the cradle to the grave. A Stocks and Shares ISA allows for capital investment into financial markets, therefore providing opportunity for greater financial return within a tax efficient environment. Investment Champion can facilitate this investment within a range of dynamic portfolios suitable for different risk profiles. The specialist investment team at TPO manages a range of portfolios designed to work for people with different objectives and risk appetites. Each portfolio contains a diverse mix of funds which will aim to provide different rates of portfolio return within a designated risk mandate. Starting your investment journey is an exciting prospect, and Investment Champion can provide a simple, affordable and transparent investment solution.