Struggling to understand what an ISA is? Don’t worry, I’m here to help. In this post I’ll explain the basics so that you can decide whether to open an ISA or not.
You may have heard people talking about cash ISAs and investment ISAs, but in this post I’ll just talk about cash ISAs for now.
What is an ISA?
ISA stands for Individual Savings Account and this type of account was introduced by the government in 1999 to encourage people to save money.
If you’re looking to save up a large sum of money over time, or you already have money in a traditional savings account, you may benefit from opening an ISA. Basically, an ISA lets you save up to £15,000 a year while gaining tax-free interest. From April, you’ll be able to save up to £15,240 a year.
What do you mean, tax-free interest?
When you save money in a regular savings or current account, the interest that you earn is taxed before it reaches you. So just like you’re taxed on your annual income, you’re taxed on your savings interest too.
So, in theory, since ISAs are tax-free, by placing your money in one of these magic accounts, you should earn more interest than you would elsewhere because the tax man can’t touch it.
Everyone has a tax-free allowance each year, and from April this will be £15,240.
So should I put my money in an ISA right now then?
Not necessarily. While all that free money sounds great, it’s vital that you check interest rates before you save. ISA rates are currently at an all-time low, meaning that even though the interest you receive is tax-free, it’s likely that you will get a higher interest rate elsewhere. If you have a savings account with a much higher interest rate than you’d get with an ISA, you’ll probably still be better off sticking to what you’ve got even though you’re getting taxed.
For example, let’s imagine you have just two options:
- You could choose a regular savings account that is offering 4% interest on savings. But, 20% of the interest that you should get is deducted before it reaches you.
- You could choose an ISA that is offering 1% interest on up to £15,000. No tax is taken and so you get your full 1%
Even though you’d get taxed in the first option, you’d still get more for your money than you would in the second option.
Why do people bother with ISAs?
Well, aside from the fact that interest is tax-free, one reason many people get ISAs is the fact that over time, interest rates are likely to rise again, and when they do, your savings will get a welcome boost.
Remember that each year you can place up to £15,000 in an ISA account. As unrealistic as it is for most, let’s imagine you were able to save that kind of money every year for five years. After five years this money would total £75,000, and if interest rates were to suddenly shoot up, you’d be loving life with all the interest you’re getting. This money would continue to accrue interest as long as it’s kept in the ISA account.
If, however, you were to wait until interest rates were to rise before placing your money in an ISA, you couldn’t place more than £15,000 in your account.
So should I get an ISA or not?
It’s completely up to you. If you decide that you do want one, you can get an ISA from most banks, but make sure you do your research first to find the best rates and terms and conditions to suit you. Some ISA providers will let you dip into your ISA as often as you like, but others require you to give notice before you withdraw cash. There are also fixed rate ISAs which will only let you deposit one lump sum. Your money will then be locked away out of your reach for a certain period of time. If you want easy access to your cash, make sure you say so and choose the right one.
What is the Help to Buy ISA?
If you’ve been following the news recently, you may have heard people talking about the Help to Buy ISA. In his annual Budget announcement, Chancellor of the Exchequer, George Osborne, announced that this autumn he plans to introduce a new ISA account that will help first time buyers to save up for their first house. This is likely to work in a similar way to regular ISAs, except once you’re ready to purchase a house, you’ll benefit from free money (on top of interest) from the government providing you meet their criteria. If you’re interested to read my thoughts on this new ISA, take a look at Will the Help to Buy ISA Actually Help?
I hope this blog post has made ISAs seem that little bit less confusing. Know a bit about ISAs and think I’ve missed some basic points? Let me know in the comments below.