What is an ISA?
An ISA (individual savings account) is a scheme that offers individuals the ability to have tax-free savings, which can be held in cash, shares and unit trusts. The amount of money that individuals can invest into ISA accounts may vary depending on the current tax year.
These accounts are exempt from income tax and capital gains tax on the investment returns, and no tax is payable on money withdrawn from the scheme. Ultimately, ISAs allow individuals to create a portfolio that's sheltered from the taxman.
There are two main types of ISA.
Cash ISAs
This is effectively an account that pays interest tax-free, as opposed to savings accounts on which you would pay tax such as fixed rate bonds, notice savings accounts and easy access versions. It can include savings in bank and building society accounts, in addition to some national savings and investments products.
Pros
- You can choose from a range of products designed to meet different needs, Instant Access, Regular Savings, or Fixed rate
- They don't end when the tax year does. So your money will continue earning you tax free interest as long as hold onto it
Cons
- The potential return is much lower than that of a stocks and shares ISA
- Some charge fees for withdrawing money from the account
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Stocks and shares ISAs
These allow you to invest into range of investments, such as government and corporate bonds, property and stocks and shares as part of your allowance. Because they are held in an ISA, any gains you make are tax efficient, helping you to save some tax depending on what investments you have and what levels of tax you pay.
Stocks and shares ISAs can include shares in companies, unit trusts and investment funds, corporate bonds and government bonds.
Pros
- Higher potential returns than a cash ISA
- Gains you make are protected from capital gains tax
- Higher-rate tax payers will pay less income tax on any dividends they may get
Cons
- These are higher-risk investments – shares purchased can lose value just as they can gain value
- This type of investment should be considered as part of a long-term financial plan
Read more about the Stocks and Shares ISA
What you need to know about ISAs
- Within a stocks and shares ISA, you pay no capital gains tax and no further tax on any income
- You don't need to declare ISAs on your tax return
- Any UK resident aged 18 or over (16 for cash ISAs) can invest. There is no upper age limit and you can withdraw your tax-efficient savings whenever you need
- The amount you can invest each tax year is decided by the government; for the 2014–15 tax year, the allowance was £15,000
- In many cases, it costs no more to hold cash and investments inside an ISA than to hold them outside, so investors can receive these benefits for free
- Since the income is not taxable it does not count for age-related personal income tax allowance reduction (although this age-related element is being phased out)
ISA alternatives
EIS funds
An Enterprise Investment Scheme fund, or EIS fund for short, is a managed investment vehicle that raises cash from individuals and institutions for the purpose of investing in a portfolio of EIS-eligible ventures. EIS funds offer generous tax breaks including relief of 30% the amount invested off your tax bill. SyndicateRoom operates a passive EIS fund called Access EIS – you can learn more about it here.
P2P loans
Peer-to-peer (P2P) loans offer those interested in taking on a little more risk the chance to select directly who to lend money to. Cutting out the bank and many other intermediaries, P2P websites can currently offer lenders anywhere from 10x to 15x the returns of a savings account. Find out more about peer-to-peer lending.
Savings account
While putting your money into a savings account is normally seen as the safe choice, the limited interest earned on a savings account means you’re not likely to see much by way of real returns.
