How do ISAs work?

8 April 2024

6 min read

What is an ISA and how does it work?

An Individual Savings Account (ISA) is a tax-free savings account in which you can invest up to a set amount of money each tax year. The main difference between an ISA and any other savings account is that it offers tax-free interest payments, which you wouldn’t get with a savings account if you earned more than £1000 of interest in a tax year.

The maximum amount that you can invest in an ISA is referred to as your ISA allowance and is set by the UK Government. You can use your ISA allowance in addition to your Personal Savings Allowance, which came into effect on 6th of April 2016. The PSA allows you to earn up to £1,000 tax-free interest if you are a basic-rate taxpayer and £500 if you are a higher-rate taxpayer. Additional rate tax payers do not get an allowance.

A tax year runs from 6th April to 5th April the following year and you can open an ISA at any point during this time period.  It’s up to you whether you want to deposit a lump sum or save regularly throughout the year.

What does ISA allowance mean?

Everyone has an ISA allowance of £20,000*. This is the maximum amount you’re allowed to pay into ISAs during a tax year (subject to HMRC ISA rules).

A tax year runs from 6th April to the 5th April the following year.

You can choose to split the allowance between different types of ISA.

*This is subject to change

What types of ISAs are there?

Although the range of ISAs available differ between providers, there are 6 main types of ISAs:

Cash ISAs

A Cash ISA works like a normal savings account, although any interest earned is tax-free. You can usually open a cash ISA if you’re a UK resident aged 18 or over. To find out more about the Cash ISAs The Co-operative Bank offers, visit our dedicated savings accounts page.

Stocks and shares ISAs

A Stocks and Shares ISA (also known as Investment ISA) allows you to invest in funds, bonds, and shares of individual companies.

Keep in mind that there is always a risk involved when you invest in a stocks and shares ISA as there is no guaranteed return and the value of your investments could go up as well as down.

To open a stocks and shares ISA you usually have to be a UK resident and 18 years or over. 

Junior ISAs

A Junior ISA allows you to save money on behalf of your children or grandchildren. You can open a Junior ISA as long as the child is under the age of 18, lives in the UK and doesn’t already have a Junior ISA.  Where a Child Trust Fund is held for a child, these can be transferred to a Junior ISA however, you cannot have a Junior ISA as well as a Child Trust Fund.

Lifetime ISAs

The Lifetime ISA (which is also known as a LISA) is a government incentive which helps people save for their first home or retirement. To open a LISA you must be at least 18 but not older than 40. You can deposit up to £4,000 each year, until you’re 50. The government will add a 25% bonus to your savings, up to a maximum of £1,000 per year.

Help to Buy ISAs

The Help to Buy ISA was a government incentive to help people save a deposit towards their first home. To qualify you must have been a first time buyer and not own a property anywhere in the world. Unfortunately this ISA is now closed to new applications from November 2019.

Innovative Finance ISAs

An Innovative Finance ISA (IFISA) helps you earn tax-free interest on peer-to-peer lending. The IFISA offers the opportunity to lend your money to a mixture of individuals, businesses and infrastructure projects. Like any form of investment, IFISAs come with some risk and are not covered by the Financial Services Compensation Scheme (FSCS). 

Additional Permitted Subscriptions

From 6th April 2015 additional permitted subscriptions on top of the annual ISA subscription limit are available to the surviving spouse or civil partner of an ISA investor who died on or after 3 December 2014. These subscriptions can be made into a cash, stocks and shares or an innovative finance ISA.

Some providers offer flexibility with Cash ISAs, and the cash element of a stocks and shares ISAs or an innovative finance ISA. This means you can replace any funds you withdraw without affecting your current year allowance. Not all providers offer flexibility though so it’s worth checking with your chosen provider.

How do I apply for an ISA?

Like savings accounts, ISAs are available from most banks and building societies. You can usually open an ISA online or in branch, depending which lender you choose.

Can I switch my ISAs from previous tax years?

If you hold an ISA that you’ve subscribed to in previous tax years, you can transfer it between ISA providers without losing the tax-free benefits but you must approach your chosen new ISA provider to do this on your behalf.

It is worth checking whether your existing ISA provider has any penalties for transferring to another ISA provider. You should then weigh up whether it's worth paying the penalty in order to secure an improved interest rate. It is essential that you arrange your transfer through your new provider. If you were to withdraw the money and reinvest it yourself, you would be subjected to rules surrounding new deposits. This would result in you losing the tax-free status of the funds. 

If you decide to transfer your ISA to a new provider, they will normally ask you to fill out an ISA transfer form. You can sometimes fill out this form online or over the phone depending on the provider. They will need your previous account details so make sure you have these to hand.

Can I withdraw money from an ISA?

Every ISA is different, and depending on what type of account you hold, restrictions and penalties may apply. You can make withdrawals from most ISAs assuming the account terms and conditions allow this. Any withdrawal of funds cannot be replaced unless you still have some of your remaining ISA allowance for the tax year or if your ISA offers flexibility. Remember though that if you wish to transfer your funds to another ISA provider, you must contact your chosen provider to do this on your behalf so you don’t lose the tax free benefits.

What’s the difference between an ISA and a savings account?

Interest earned from an ISA is tax-free and there is a limit in how much you can invest in each tax year. Whereas there is no limit on how much you can invest in a savings account and you would pay tax on interest after the first £1000 of interest earned or £500 if a higher rate tax payer. Additional rate tax payers do not get an allowance.

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