The beginner’s guide to Isas: how to invest and save, tax-free

First launched in 1999, Isas – more formally known as Individual Savings Accounts – have become a hugely popular way for savers and investors alike to shield their money from tax. 

That’s because savings interest and investment returns earned from money held in an Isa is tax-free, shielding you from potential income tax, capital gains tax and dividend tax charges.

But there are several rules you’ll need to abide by to keep this tax-free status. For instance, all adults in Britain get an Isa allowance of £20,000 – this is how much you can deposit into Isa accounts during each tax year. 

Plans announced in the 2024 Spring Budget will see an extra £5,000 Isa allowance for those willing to invest via a Great British Isa, for UK-listed equities.

You can either save everything into one Isa, or split it across several, but you can currently only pay into one of each type of Isa each year. From April, Isa savers will be able to pay into more than one of the same type of Isa in the same tax year in a bid to make things simpler for savers and investors.

Here, Telegraph Money takes a look at the different types of Isas to help you decide which options could work best for you. In this guide we will cover: 

• Should you save with a cash Isa?
• Investing with a stocks and shares Isa
• Lifetime Isas: save for first home or retirement
• Innovative Finance Isas for peer-to-peer investing
• Junior Isas for under-18s
• Plans for a Great British Isa 
• Four Isa rules you need to know

Should you save with a cash Isa?

Cash Isas are offered by banks, building societies and National Savings and Investments (NS&I).

They function in pretty much the same way as normal savings accounts – the main differences being the restrictions on how much you can pay in, and how you switch to a new account. 

As you can currently only pay into one cash Isa each tax year (though this is set to change from April 2024), if you see a better deal elsewhere after you’ve already started saving, you have to make an Isa transfer – moving all the cash you’ve deposited during the current tax year to the new account. You have to submit an Isa transfer request with the new provider to make this happen.

It’s worth noting that the top cash Isa rates can usually be beaten by their savings account equivalents. There are a few possible reasons for this. According to Moneyfacts, providers have a greater administrative burden of offering Isas (such as reporting to HMRC each year) and may offer lower rates as a result. It could also be that the complexity of Isas puts off some providers, reducing the competition and incentive to make rates more competitive.

This means basic-rate taxpayers can earn up to £1,000 in savings interest in each tax year; reducing to £500 for higher-rate earners. If you pay additional-rate tax, you don’t qualify for this allowance.

Use our savings tax calculator to see how much you’d pay if your cash was held in a savings account, so you can decide whether it’s worth switching to a cash Isa instead.

You’ll have to consider the trade-off between how much tax you could save with an Isa, vs the extra interest you could earn with a savings account.

Investing with a stocks and shares Isa

A stocks and shares Isa can hold a range of investment products, and any investment growth or interest earned within the account is tax-free.

Investments that can be held in a stocks and shares Isa include unit trusts, investment trusts, exchange-traded funds, individual stocks and shares, corporate and government bonds, and Open Ended Investment Companies (OEIC).

Lots of banks offer stocks and shares Isas, along with a host of investment platforms. Depending on how you’re investing, you could expect to pay fees charged by the investment platform or financial adviser, as well as charges levied by individual fund managers if you’re buying funds. These fees will vary depending on the providers you use and the value of your investment.

You can only pay into one stocks and shares Isa in each tax year. As with cash Isas, it’s possible to transfer funds from current or previous tax years to a new account, and you have to fill out a transfer request form to do so. 

Investment returns can produce higher returns than cash – but this isn’t guaranteed and will depend on the performance of the investments held in the account. If you’re thinking about investing, it’s good to go in with a long-term view in mind – ideally, you’ll be looking to invest for at least five years. This gives investments time to grow, and will hopefully even out any short-term volatility.

Lifetime Isas: save for first home or retirement

Lifetime Isas (Lisas) were introduced in 2017 to help people either save up to buy their first home, or for retirement savings. They can be opened by those aged 18 to 39, and you can deposit up to £4,000 a year – anything you pay in will be deducted from your £20,000 Isa allowance. You can choose between cash or stocks and shares Lifetime Isas.

The biggest bonus Lisas offer is that the Government tops up your savings with an extra 25pc, which means you could get up to £1,000 extra each year. 

However, you can only keep saving into the account until you turn 50. If you’re saving for retirement, you’ll then have to wait until you turn 60 before you can access your savings – but they can then be spent however you choose.

Only first-time buyers can use Lisa savings to buy a home, with a maximum purchase price of £450,000. You cannot own, or have owned, a home in Britain or anywhere else in the world. You must also be planning to live in the house you are buying and use a traditional repayment mortgage.

This purchase limit can be a problem in expensive parts of the country, and can leave savers vulnerable to the biggest Lisa catch - the withdrawal penalty. 

If savers withdraw Lisa savings for any reason other than buying their first home or to use after they turn 60, they will face a 25pc exit penalty. This removes the government bonus and 6.25pc of savers’ own money, leaving them worse off than they were to start with. 

House hunters who find they can no longer find a property worth less than £450,000 will also face this charge.

Savers who have a Lifetime Isa that is no longer fit for their first home could use it to fund their retirement instead, but this comes with potential downsides. Paying into a Lisa is less lucrative than paying into a pension, which can include employer-matched contributions and tax relief at your highest rate of income tax.

Innovative Finance Isas for peer-to-peer investing

This relatively niche type of Isa allows you to invest in loans given to consumers and small businesses. Also known as the “peer-to-peer” Isa, you lend your money to borrowers in return for a set amount of interest based on the length of time you are prepared to lock your money away for. 

You can choose to invest your full £20,000 allowance into an Innovative Finance Isa each year. However, fewer providers offer these Isas than other types, and each one differs in the rates they offer, who they lend to and how they structure the investments. Make sure to read up on what you’re investing in before you go ahead and part with your cash. 

Experts have warned that some Innovative Finance Isas pay little more than cash accounts, despite the higher risks involved.

Most providers have a back-up fund that will pay out if borrowers default on their loan repayments. However, if a large number of borrowers were to default at the same time then providers may struggle to pay out, and could even go bust.  

If the worst should happen, money held within an Innovative Finance Isa is not protected under the Financial Services Compensation Scheme (FSCS), so you could stand to lose your savings.

Junior Isas for under-18s

Parents can open a Junior Isa (Jisa) for their children, and save up to £9,000 in each tax year. If you have more than one child, you can open a Jisa for each of them and pay in £9,000 per child. This does not form part of your £20,000 allowance for other types of Isas.

There are both cash and stocks and shares Jisa options to choose from, but children can only hold one of each at a time. Any money you put in is locked away until the child turns 18, at which point their account becomes an adult Isa they can manage themselves. 

If you have a large amount to save for your kids, children aged 16-17 can hold a Jisa and an adult cash Isa at the same time, meaning there’s a brief opportunity to deposit up to £29,000 tax-free. 

However, this will no longer be possible after April 2024. In a policy document released alongside the 2023 Autumn Statement, only over-18s will be able to open an adult Isa from the next tax year.

Cash Jisa rates tend to be more generous than adult cash Isas, but can usually be beaten by their savings account equivalents – and the tax-free status is less of a draw. 

Children’s income can be taxed, but it’s very rare; given they’re not usually receiving any other earnings, they could combine the personal allowance, savings starting rate and personal savings allowance to earn up to £18,570 savings interest tax-free.

A stocks and shares Jisa could be more beneficial; Jisa savers could have up to 18 years of investment growth before they can access their money and – if they’re lucky – it could grow significantly over this time. 

Plans for a Great British Isa

In a bid to encourage more investment in homegrown firms, Chancellor Jeremy Hunt announced the launch of a Great British Isa in his 2024 Spring Budget. 

The plan is for savers to receive an extra £5,000 allowance to invest in UK-listed equities, and receive growth tax-free.

It is not yet clear which platforms will offer it, or how the £5,000 allowance will interact with the rest of the £20,000 allowance, but experts have pointed out that only a small number of investors will benefit from being able to deposit more cash, with most savers unable to use their whole Isa allowance as it is.

There is a consultation on this new kind of Isa out now, which will close on June 6, 2024. The Government will issue a response after its closure, but has already acknowledged that provider platforms will need time to update their systems before the new Isa can be offered, so delays are likely.

Four Isa rules you need to know

Any allowance you don’t use, you’ll lose

All Isa allowances renew on 6 April at the start of a new tax year, and it’s not possible to carry over anything you haven’t used in the previous year.

You can inherit thousands in Isa savings, tax-free

When a spouse or civil partner dies, there’s a tax-saving mechanism that means their surviving partner can inherit their tax-free savings – but you’ll need to follow the rules, and they can be tricky.

You can lose tax-free status if you transfer funds yourself

Anyone who tries to bypass the official Isa transfer procedure could become unstuck, because as soon as your money leaves its protective Isa “wrapper” it becomes taxable. This would be the case if, for example, you transferred the balance of your cash Isa to your current account before later sending it to a different cash Isa. 

You could get a tax bill if you exceed your allowance

If you accidentally pay in more than £20,000 in the same tax year, HMRC will usually detect the error, as Isa providers are required to submit figures to the tax authority each year. 

If it’s a one-off mistake, you could be let off with a warning letter. Otherwise, your Isa provider may be instructed to remove the excess money that was deposited, and you could be taxed on any interest or growth it earned.