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What different types of ISA are there? And what's the best ISA for me?

Posted on 01/08/2018, by Joe Jones

With a whopping £62.8 billion subscribed to ISAs in the 2016-17 tax year, it’s pretty clear us Brits like our tax-free savings. However, as times change, our taste for how we like our tax-free wrapper served up is, too.

In the 2015/16 tax year, cash ISAs were preferred by 80% of subscribers. One year later, this dropped to just over 60%.(HMRC)

As inflation continues to outpace interest rates, Britain’s savers are clearly starting to look at alternative tax-free options. But, it turns out there’s quite a lot of them. It can make it hard to work out which one is right for you. So, what are they?

Here’s our overview of some of the benefits and drawbacks of the different types of ISAs currently available. Remember, the specifics of each ISA product – such as rate, term and charges – will vary depending upon the provider. Also, note that tax treatment depends on individual circumstances and is subject to change.

The big three

Cash ISA

Where else to start? The bread and butter of the ISA world, cash ISAs work like your normal bank savings account. You invest your money with a cash ISA provider, in exchange for a small, tax-free return.

The rate of interest tends to rise and fall in line with the Bank Rate, set by the Bank of England. With this currently set at 0.75%, the average cash ISA from the ‘Big Five’ high-street banks are returning only 0.39%.1 If you’re willing to lock your money away a bit longer you can get a better rate in a fixed-term product, but you’ll still struggle to beat inflation (2.3% at the time of writing).2

However, despite the low returns, cash ISA investments have little element of risk. Being saved in a standard bank account, they are protected by the Financial Services Compensation Scheme (FSCS) – meaning all your savings will be guaranteed, providing the amount you have saved with that financial institutional doesn’t exceed £85,000.

Benefits

- FSCS coverage

- Stable return

Considerations

- Low rate of return compared to other ISAs; currently below inflation.

Stocks & Shares ISA

A stocks and shares ISA gives individuals the opportunity to take more risk, in exchange for a potentially greater return. This is classed as an investment, rather than savings, as the money is used to buy stocks, bonds and/or funds, in the hope that the value will increase.

However, along with the potential for much higher levels of interest, there is also the possibility that the value of your investment could fall, too. You may get back less than you put in. This is where it’s important that you’re clear about how much risk you’re willing to take as an investor.

It’s difficult to give an accurate average rate of return for a stocks & shares ISA, however it tends to be up to around 9% (the total return for the FTSE All Share index since 1983 was 8.7%).

Benefits

- Potential for high rates of return.

Considerations

- Your money will be put at risk – you could end up with less money than what you initially put in.

- Many providers charge a fee for you to open and hold a stocks & shares ISA.

- Unlikely to be instant access.

Innovative Finance ISA

Still relatively new to the game, the Innovative Finance ISA has given ISA investors a way to earn an inflation-beating return, without putting their money in the stock market. Instead, their money can be invested in peer-to-peer loans.

The nature of these loans can vary wildly, and will depend on the product and provider. Some will invest your money in unsecured business or personal loans that can achieve rates as high as 8-12%, however a great deal more risk will come with that. If the borrower fails to repay their loan, there’s no asset to help repay the debt.

On the other hand, there’s secured peer-to-peer lending. Octopus Choice is one example, which invests all lender’s money in property-backed loans. This helps mitigate the risk to investors, as, should a borrower fail to repay their loan, the property can be sold to fund the debt.

Benefits

- Potential for high rates of return.

- Option to choose secured investments

Considerations

- Not covered by the FSCS

- Your money will be put at risk – you could end up with less money than what you initially put in.

Other types of ISA

Lifetime ISA

A Lifetime ISA (Lisa) is designed to support individuals saving for retirement or purchasing their first property. Alongside being tax-free, the government will also pay you a bonus of 25% on what you save each year. However, this only applies if you withdraw the money to purchase your first home, or once you reach the age of 60.

You are limited to putting in a maximum of £4,000 a year, and can only do so between the ages of 18 and 50. Those making a withdrawal before they are 60, or not to purchase a new property, will lose their bonus and may be penalised.

Lisas are available either as a cash or stocks & shares offering, meaning there are options for people with different risk/return appetites.

Help-To-Buy ISA

Much like a Lifetime ISA, a Help-To-Buy (HTB) ISA is geared around supporting people saving for a house deposit. The differences being that:-

- You can open one from the age of 16.

- There are only cash options available.

- There’s no penalty for withdrawing without purchasing a property, although you will lose your bonus.

- You’re restricted to only putting up to £1,200 in during the first month, then a maximum of £200 a month after that.

It’s also worth noting that you can transfer your Help-To-Buy ISA into a Lifetime ISA.

Junior ISA

Junior ISAs (JISAs) are intended to encourage parents (and ultimately young people) to save for a child’s future. The money invested in a JISA will then be transferred to an adult ISA (in the child’s name) when they turn 18.

There’s a maximum annual investment of £4,128, with the option of both cash JISA or a stocks & shares JISA.

So, which ISA is best for me?

Setting aside the Lisa, JISA and Help-To-Buy ISA – which are designed for people with specific savings goals – it really all comes down to each investor’s individual circumstances, and how much risk you’re prepared to take with your money.

For those with limited funds available, and who might need to rely on the money at some point to support themselves, instant access cash ISAs might be more sensible. Besides, you’re automatically entitled to earn £1,000 interest tax-free under the Personal Savings Allowance.

However, if you have a bit more flexibility, it’s worth thinking about what level of risk/return you’re prepared for, and whether an ISA with higher target returns could work best for you.

Either way, ISAs offer a brilliant opportunity for savers and investors to earn interest tax-free, and try to achieve their financial goals.

Remember, investing places your capital at risk. It’s important you are comfortable with this and know that you could get back less than you put in. Tax rules are subject to change and depend on individual circumstances.

1 Based on the average savings rate available from HSBC, Barclays, Santander, RBS and Lloyds on instant access ISAs, with a balance of£20,000 (Aug 2018)

2 ONS