How to choose your first ISA

If you’ve decided to get savvy and start managing your money for the future, you might have been told that an ISA is the best place to stash your savings. But how do you know how to choose your first ISA and what the hell is an ISA anyway? Don’t worry because we’ve broken it down for you into this simple expert guide.

What is an ISA?

An ISA is an individual savings account which you can either use to save cash, or to invest in stocks and shares. ISAs are offered by banks, building societies, offshore sportsbooks, online investment platforms and other financial organisations.

What are the benefits of paying into an ISA?

ISAs are a useful way to save because you can save up to £20,000 each tax year, tax free. This means you don’t have to pay any Income Tax or Capital Gains Tax on any interest or income you earn from your ISA.

You can invest up to £20,000 in ISAs each tax year – this is known as your annual ISA allowance. If you invest more than this in a tax year, the extra amount (the amount over £20,000) is not eligible for tax relief.

You can sometimes get a higher interest rate on a cash ISA than on other savings accounts, meaning you could earn extra money as you save.

What are the risks of paying into an ISA?

Cash ISAs are low risk, but Stocks and Shares ISAs carry more risk because you are investing, so there is a chance you can lose money, meaning you could end up with less money than you originally saved. You could also end up with more, so taking that chance is up to you. Innovative Finance ISAs can also carry the risk of losing money and have less protection than other ISAs.

As with any bank account, you are always at risk of theft or fraud, so make sure you avoid online scams, shop safely online and keep your savings secure.

Learn more about basic bank accounts.

What are the different types of ISAs?

When working out how to choose an ISA, there are lots of options and it can all feel a bit confusing. We’ll take you through the basics so you can make the best decision for your money goals.

Cash ISAs

Cash ISAs are savings accounts for those who want to earn tax-free interest on their savings without investing.

Some ISAs will have a limit to the number of times you can withdraw money each year, giving you more encouragement to save instead of spend. Some will be more flexible, allowing you to access your money whenever you need it. Generally, the more restrictions on withdrawals, the higher the interest rate. So, you have to think about which options match your plans.

Different providers will offer different interest rates, so it’s worth looking around regularly to find the account with the highest interest rate, and making a switch if you find you can earn more interest elsewhere.

Who can open a Cash ISA?

You can open a Cash ISA in the UK if you are over 16 years of age and are a UK resident.

Junior ISAs

A Junior ISA is a savings account your family can open for you. The interest on your savings will also be tax free.

Family and friends can save up to £9,000 for you in the 2023/2024 tax year.

A Junior ISA can be opened as a Cash ISA or a Stocks and Shares ISA.

Who can open a Junior ISA?

Your family can open this on your behalf when you are under the age of 18 and can grant you access to the savings when they choose to do so.

Lifetime ISA

A Lifetime ISA is designed for long-term saving and can either be used to save for a deposit for a first home, or for your future retirement.

You can save up to £4,000 per year and will get an annual government bonus of 25% of your savings. If you save the full £4,000 for example, you will get a £1,000 bonus!

You should ideally only withdraw money to make a payment towards your first home, or to use your savings as a pension. You can withdraw for other reasons if you wish, but you will lose your 25% bonus.

A Lifetime ISA can be opened as a Cash ISA or a Stocks and Shares ISA.

Who can open a Lifetime ISA?

You can open a Lifetime ISA between the age of 18 and 40 and you can pay into it until you are 50 years old.

Stocks & Shares ISAs/Investment ISAs

Stocks and Shares ISAs, sometimes also called Investment ISAs, are accounts that allow you to invest your savings in a range of different shares, funds, trusts and bonds.

A Stocks and Shares ISA is intended to be a medium to long-term commitment (think at least 5 years). The idea is that your investments slowly grow over time, with losses and gains along the way, so ideally you wouldn’t withdraw money regularly, although there are no restrictions on this.

You can either do your research and buy your own shares or pick an account that manages your investments for you. This also allows you to choose which kind of markets you want to target and which you want to avoid (for example you can choose a green portfolio which invests in things like renewable energy).

Important: Stocks and shares ISAs put your capital at risk, so it’s important to consider this before you choose this type of account. You must be prepared for your savings to dip sometimes as well as grow, so if this idea makes you anxious, then this type of account probably isn’t for you.

Who can open a Stocks & Shares ISA?

You can open a Stocks & Shares ISA if you’re 18 or over and a UK resident.

Innovative Finance ISAs

An innovative Finance ISA is one that lets you use your £20,000 ISA allowance to invest in ‘peer-to-peer lending’; this is when you lend money to borrowers and businesses using an online portal. Those who borrowed money then pay it back with interest. This interest will be tax free.

These can be more risky than other forms of ISAs as they offer less protection against losses and there’s a chance that borrowers could default on their payments. It can also take a long time to withdraw money.

Who can open an Innovative Finance ISA?

Anyone aged 18 or over who is a UK tax resident.

How to choose an ISA

This entirely depends on your goals and what you intend to use your savings for. The questions you should consider when thinking about how to choose an ISA should be:

What do I want to do with my money?

For example, if your goal is to buy your first home then the Lifetime ISA is probably your best bet.

How long am I prepared to save for?

For example, if you are putting money aside for a rainy day and want to be able to take it out if you need it, a Cash ISA might be best for you.

How much risk do I want to take with my money?

If you are risk averse and would feel worried about changes in the financial markets, a Cash ISA, or a Lifetime ISA (the cash version) might suit you better than a Stocks and Shares ISA.

How do I set up my ISA?

Here are the key steps for setting up your ISA:

• Choose the right type of ISA for you based on your money goals.
• Use money comparison websites and read reviews to find the provider with the best interest. rate and the one that is the best fit for your goals and ethics.
• If you’re thinking of investing in stocks and shares (or any other type of investments) you might want to speak to an independent financial adviser for advice (there will be a fee for this).
• Download the app for the provider on your phone.
• Set up your account via the app, website, or in the local branch of your chosen bank.
• Some ISAs will require a minimum deposit, so you will need to make this payment.
• You might want to set up a direct debit with a weekly or monthly payment, so you know you are saving regularly.

How many ISAs can I have at one time?

You can pay into one of each kind of ISA each tax year. Your annual ISA allowance is £20,000 but you can split this amount between the different types of ISAs (subject to the rules) if you want to.

You can keep old ISAs from previous years open if you want to. If you pay into one of these, you will not be able to open a new one. So, if you opened a cash ISA last tax year and continue to pay into it, you will not be able to open a new cash ISA this tax year as you are only allowed to pay into one of each type of ISA during a single tax year.

The Mix would like to thank Experian for their support with this article.