As the new tax year approaches and you're finishing university, you may be starting to think about saving for your financial future.
Whatever your goal – whether it’s buying a car or putting down a deposit on a house – it’s a good idea to develop healthy financial habits as early as possible.
One way to begin building up a savings pot is by opening an Individual Savings Account (ISA). In this blog, we’ll discuss what an ISA is and how it might benefit you.
What is an ISA?
Put simply, an ISA is a tax-free way to save. Unlike ordinary savings accounts, which are taxed at source, you can contribute up to the maximum annual allowance (currently £20,000 per tax year) without having to pay tax on your savings – meaning your pot will grow at a much quicker rate.
It’s important to note that with an ISA, you cannot carry your allowance over to the next tax year. So, if you don’t use all of it that year, you will lose it. This is why it’s often a good idea to budget and plan your instalments to make the most of the allowance.
Types of ISA
There are four types of ISA you can choose from, and your choice will depend on both your individual circumstances and your appetite for risk.
As it currently stands, you can only contribute to one of each type of ISA per tax year. However, from 6th April 2024, you will be able to open multiple ISAs of the same type in the same tax year. Although, you still won’t be able to exceed the annual allowance of £20,000.
The four types of ISA are:
- Cash ISAs
- Stocks and shares ISAs
- Lifetime ISAs
- Innovative finance ISAs
There are also junior ISAs that parents can set up on behalf of their children. As the ISA is in the child’s name, it doesn’t affect the parent’s allowance.
Cash ISA
As the name suggests, this type of ISA allows you to earn interest on the cash you invest. The amount of interest you earn will depend on whether you choose a variable or fixed-rate ISA.
The advantage of a variable rate is that you can withdraw your money when you need to. However, these types of ISA usually attract a lower rate of interest in comparison to fixed-rate options, where you will be expected to leave your money untouched for longer.
So, if you want to start saving and would like the security of knowing you can still access your money if you need it, a variable rate ISA is a good way of seeing your savings increase at a faster rate than an ordinary savings account.
If you don’t need your money quickly, and you’re able to leave your cash tied up for longer, then a fixed-rate ISA is a good option.
Stocks and shares ISA
With this type of ISA, your money is invested in stocks and shares rather than just held in cash. So, your return will depend on how well those stocks and shares perform.
Some accounts will let you choose which stocks and shares your money is invested in, while others, such as the Wesleyan Stocks and Shares ISA and the Wesleyan Unit Trust Managers Unit Trust ISA, see your money placed in funds that are managed for you.
As with cash ISAs, you won’t pay tax on the money you invest in these funds, and this can be a good way of growing your investment quickly. However, these returns depend on the performance of the stock market, which can see share values go down as well as up. It’s riskier than a cash ISA, and you may get back less than you put in.
If you opt for this type of ISA, then it’s advisable to view it as a medium-term investment. This is because it’s best to leave your money in place for at least five years to allow for growth.
Lifetime ISAs
If you’re looking to step onto the property ladder, a lifetime ISA might be a good option to consider. Lifetime ISAs are available to people aged 18-39, and are designed to help you save for your first house or your pension.
You can save up to £4,000 of your £20,000 annual allowance in a lifetime ISA, and the government will add 25% until you turn 50. This means that if you contribute the whole £4,000 per year, you could get an extra £1,000 added to your pot.
Another good thing about the lifetime ISA is that if you’re buying a house with another person, and both of you have a lifetime ISA, you can pool your funds together for the purchase.
However, you can only use the proceeds to buy a house with a value of less than £450,000, which isn’t as easy as it sounds in some parts of the country. What’s more, if you’re using it to boost your pension, you can’t touch it until you’re 60 years old.
It’s important to note that if you want to take funds out for a purpose that isn’t to buy a property or build your pension, your money will be subject to a 25% charge. If you withdraw all of the money for a purpose that isn’t a property or pension, you might get back less than you put in.
Innovative finance ISAs
Innovative finance ISAs (or IFISAs) use peer-to-peer lending rather than cash or stocks and shares. Your money is matched to individuals or businesses looking to borrow through a lending platform. These types of ISA offer a higher rate of interest than some other types of ISA.
While this can be a good way to get great returns on your investment, it carries a greater level of risk than a cash ISA. Borrowers may default on their loans and there can be limited protection if this happens. What’s more, not all IFISAs are protected by the Financial Services Compensation Scheme.
Paying into and withdrawing from your ISA
Most ISAs will allow you to pay either a lump sum amount or a regular monthly amount. So, should you find yourself with some spare money (it might happen!), you’re free to top up your ISA to the maximum limit for that tax year.
Any money you withdraw from your ISA will be free from income tax or capital gains tax, which is good news. You may have to pay a fee for withdrawing, but that will depend on the terms of your account – so make sure you read the small print.
With stocks and shares ISAs, you should be prepared to leave your money invested for at least five years. This is something that is important to factor into your considerations.
Getting the right advice
Hopefully you now feel more informed about the different types of ISA available and the risks and benefits attached to each one.
If you’re still a little uncertain about which one(s) would be right for you, it might be a good idea to get some advice. If you would like to chat to someone about your options for saving and investing, get in touch with a Specialist Financial Adviser from Wesleyan Financial Services to discuss your circumstances in more detail.
Remember the value of investments can go down as well as up so you may get back less than you put in.