The essential guide to Isas: What you need to know about tax-free saving and investing – and how to get started

It is almost the end of the tax year on April 5, so now is the time to take advantage of your annual Isa allowance before you lose it.

An Isa – or an Individual Savings Account to give it the full official name – is a wrapper that protects your savings or investments from tax on interest, profits and dividends.

And with higher interest rates pulling more into the savings tax net and a raid on both capital gains and dividend taxes looming, using an Isa has become even more important.

In our essential guide to Isas, we explain everything you need to know: from the difference between a cash Isa and a stocks an shares Isa, to the benefits of investing or saving in an Isa, and the rules that you need to stick to.

What is an Isa?

An Isa is a tax-efficient way of saving or investing money. It is described as a wrapper around your savings and investments that means all interest, profits and dividends can be earned free of tax.

There are different types of Isa to help you save or invest depending on your goals.

The two main types are Cash Isas (for saving) and Stocks and Shares Isas (for investing). 

There are also Lifetime Isas (for a first home deposit or retirement) and Innovative Finance Isas (for peer to peer investments) and Junior Isas (for those under 16).

Why should you save in a cash isa?

Anyone who is a resident in the UK and aged 16 or over can save into a Cash Isa. Outside of a cash Isa, any interest earned is subject to tax above a certain level, known as the personal savings allowance.

The personal savings allowance means basic rate taxpayers can earn £1,000 of interest tax-free. 

But higher rate taxpayers at the 40 per cent rate only get a £500 annual personal savings allowance.

Meanwhile, additional rate taxpayers (those paying 45 per cent tax) get now allowance at all.

When interest rates were on the floor, the personal savings allowance protected many basic rate taxpayers and some higher rate taxpayers from tax on their interest.

But the rapid rise in interest rates over the past year has pulled up savings rates and this means that more are now being dragged into the savings tax net. 

When top easy access deals paid about 1 per cent, a basic rate saver needed £100,000 or more in savings to breach the personal savings allowance and a higher rate saver needed £50,000

Now with top easy access rates about 3 per cent, those figures are about £33,400 and £16,700.

This is why a cash Isa has become more essential for many.

Why should you invest in an Isa?

There are plenty of reasons why you should consider investing in a stocks and shares Isa, but the chief one is to protect against tax eating into your returns.

It has become even more important to hold your investments in a tax-free wrapper, as a tax raid by Chancellor Jeremy Hunt will soon see tax-free allowances for both dividends and capital gains slashed.

The annual capital gains tax-free allowance will be cut from £12,300 to £6,000 from 6 April 2023, and fall to £3,000 from the start of the 2024 tax year.

Currently, a higher rate taxpayer making £15,000 of capital gains in a year would pay tax on just £2,700 of that profit, landing them with a £540 bill.

But if they were to make the same gains after 6 April 2023, they would be liable for tax on £9,000 of their profits, meaning a tax bill more than three times bigger at £1,800.

Similarly, the dividend tax-free allowance will be cut from £2,000 to £1,000 next month, and then to £500 from 2024.

A higher rate taxpayer investor getting £2,000 of dividends each year would currently pay no tax on their income from investments.

From 6 April, they would face tax on the £1,000 of their dividends above the new £1,000 tax-free allowance and lose £337.50 to tax.

Dividends are an important way for some investors to receive income in the current inflationary environment and are proven to be a long-term driver of stock market total returns, so protecting them in an Isa will help.

As an added bonus, you also don’t need to declare capital gains or dividends from within an Isa in a self assessment tax form, so it saves on paperwork and admin too.

Isas vs fiscal drag 

  • In the Autumn Statement, Chancellor Jeremy Hunt froze the higher rate tax threshold at £50,270.
  • This creates something called fiscal drag, as more people are pulled into a higher tax band as their earnings rise. 
  • It means a record number of people will find some of their earnings fall within the higher 40 per cent income tax.
  • For savers, it means more will have their personal savings allowance reduced to £500. 
  • For investors, it means they will be pushed into a higher dividend tax brand, moving from paying 8.75 per cent to 33.75 per cent.
  • The additional rate tax threshold is also being lowered from £150,000 to £125,140, which will mean more dividend tax for these investors as they are pushed into the top 39.35 per cent band.
  • They will also lose their personal savings allowance once they breach the limit. 
  • Using a stocks and shares Isa or cash Isa can help investors protect their dividends and savers their interest from any extra tax due to fiscal drag or the lowering of the additional rate threshold.

How do I open an Isa? 

There are a lot of Isas out there even if you just focus on the two main types of cash Isas an stocks and shares Isas.

For cash Isas, it is important to compare rates across the whole market and not just go to your bank and building society, as they may not have the most competitive deal.

At This Is Money we regularly update our round-up Five of the best cash Isas, and you can also look through our independent best cash Isa savings tables  to see the top deals currently on offer. 

For stocks and shares Isas, each provider has a slightly different offering, with some offering services that allow you to choose from a full range of investments, some limiting choice but perhaps offering cheaper fees, and others having services that help choose investments for you.

They all have different fees and when you’re weighing up the right one for you, be aware of the service the provider offers, along with any administration or platform charges and dealing fees, and any other extra costs.

To help you compare the best investment accounts, we’ve crunched the facts and pulled together a comprehensive guide to choosing the best and cheapest investing account for you.

Can I have more than one Isa and how much can I put in every year? 

Every tax year you can put up to £20,000 of new money into all Isa savings or investment. You can choose how to split this between each type. 

You can only contribute a maximum of £4,000 per year to a Lifetime Isa.

So, for example, you can put £10,000 into a stocks and shares Isa, £6,000 into a cash Isa and £4,000 into a Lifetime Isa.

Or you could pay £10,000 into a cash Isa and £10,000 into a stocks and shares Isa, or put the whole lot into one.

While you can have more than one stocks and shares Isa or cash Isa, you can only contribute new money to one of each type in a tax year.

In practice, many people open new cash Isas each year, but tend to stick with the same DIY investing platform for their stocks and shares Isa and simply add money to that and pick their investments.

But you could open a different stocks and shares Isa, perhaps as you now wanted one that chose investments for you.

For those who want to save on invest towards their child’s future there is also the Junior Isa. There is a separate £9,000 annual allowance for this, which is the child’s and so not included as part of an adult’s £20,000 adult allowance.

When it comes to Isa allowances, it’s a case of use it or lose it. Once the end of the tax year comes around, you cannot carry over any remaining allowance.

Can I transfer my Isa?

If you want to move your money to another provider, you’ll need to transfer your Isa to ensure you keep the tax-free benefits.

Unless you have a special flexible Isa, if you withdraw and reinvest the money, you will be using up some or all of your annual allowance.

Transferring your Isa doesn’t count as opening a new one, which means you can transfer your stocks and shares Isa to a new provider and still have the option of opening another Isa later that year.

Similary, a cash Isa can be transferred to a new deal paying a better rate at any time. Read our round-up of the best cash Isas for transfers.

This works the same across all Isa types, so you can transfer a cash Isa to a stocks and shares Isa and still open another stocks and shares Isa later that year.

For example, if you’ve used £10,000 of the annual allowance before transferring, you’ll still have £10,000 left to put in a new Isa. 

But if you’re transferring a £30,000 Isa that you haven’t contributed to this tax year, you’ll still have a £20,000 Isa allowance to use in a new Isa.

Usually, there are no charges for transferring your Isa, but check with your provider as some can incur penalties, like fixed-term cash Isas.

Transferring your Isa can make it easier to manage your money, given you’re able to transfer more than one Isa. You can consolidate your Isa by moving your Isas into one of your existing accounts, or transfer them into a new Isa.

You don’t always have to transfer the whole Isa, it depends on whether it’s made up of contributions from the current tax year or built up over more than one tax year.

If you’re moving an Isa that you opened and added to in the current tax year, then you will have to transfer it all. If you’re moving an Isa you’ve contributed into for more than a year, you can transfer part of it or the whole thing.

You cannot transfer an Isa from one person to another.

Can I transfer other investments into an Isa?

Shares held outside of an Isa are liable for dividend tax on income and capital gains tax on profits.

To dodge an upcoming tax raid on both capital gains and dividends, you can do something called a ‘Bed and Isa’. 

If you haven’t used up your Isa allowance you can sell some of your shares, or funds, and then rebuy the same ones within an Isa before the end of the tax year.

Capital gains can also be crystallised in the same way to take advantage of this year’s allowance before the cut.

If you are planning to do this, do not leave it until the 5th April as it can take some time for the funds to clear.

What are the different types of Isas? 

Cash Isa

Cash Isas are the nation’s favourite type of Isa– over three times more savers pay into one every year than the number of people paying into stocks and shares Isas.

It’s worth noting that cash Isa savings rates are currently lower than the equivalent standard savings rates offered on the market, so it’s worth checking whether holding your savings in an Isa would actually earn you more.

What it can do is protect you from tax and allow you to benefit from the full rate, rather than the rate minus tax, something that’s even more important for higher rate or additional rate taxpapers. 

Our independent best buy cash Isa savings tables will give you an overview of the best deals on the market and our Five of the best cash Isas round-up features our choice of the top deals.

A cash Isa is a safe option, as savings will be protected by the Financial Services Compensation Scheme against bank or building society collapse, up to £85,000 per individual per licensed organisation. 

Over the long-term, returns from cash have lagged behind the stock market though.

Stocks and shares Isa

Any UK resident aged 18 or over can invest in a stocks and shares Isa and it provides valuable protection against capital gains tax and dividend tax.

Although there is a £2,000 dividend allowance once income exceeds this in a given tax year, you will start paying dividend tax: with basic rate taxpayers taxed at 8.75 per cent, higher rate taxpayers taxed at 33.75 per cent and additional rate taxpayers taxed at 39.35 per cent.

Any stocks and shares sold outside an Isa will also be subject to capital gains tax on profits, although there is a CGT-free of £12,300 a year for this.

Invest in an Isa and you are protected from both capital gains and dividend tax and also don’t have to fill in a tax return to declare profits or income.

If you’re looking for the most cost-effective way to invest, then an online DIY investing platform is likely to be the best course of action. 

These allow you to pick your own investments, or offer help choosing them with model portfolios, or even portfolio-choosing services.

When weighing up the right one for you, it’s important to look at the service that it offers, along with administration charges and dealing fees, plus any other extra costs. This is Money has written an extensive guide on the best and cheapest DIY investing platforms, which can help you decide. Read it here: How to find the best and cheapest stocks and shares Isa.

Lifetime Isa

This is a great option for those saving towards a deposit for their first home and can be used as part of your annual personal £20,000 Isa allowance.

Savers under the age of 40 can open a Lifetime Isa (Lisa) and until they hit 50, the Government will chip in £1 for every £4 they save, giving a £1,000 bonus on the maximum £4,000 a year you can save.

That money can either be used towards a deposit on a first home or be withdrawn from the age of 60 to help fund retirement.

However, there are two crucial rules to be aware of.

First, whether buying individually or as a couple the value of the property must not exceed £450,000.

You may also end up worse off if you decide to cash in the Isa before 60 without buying a first home. This is because a 25 per cent penalty applies to the amount withdrawn in this case.

Like with the standard Isa, you can either choose to save or invest your money via a Lisa. However, your options are more limited than with standard cash or stocks and shares Isas.

Junior Isa

Junior Isas are for those aged under 18 who live in the UK and want to save an invest tax-free. They are usually opened by parents, but grandparents and others can pay in too, and contributions are limited to £9,000 each tax year.

Just like an adult Isa, when saving into a cash Junior Isa all interest earned will be shielded from tax, while those a stocks and shares Junior Isa will shielding any dividends or capital gains from the taxman.

The £9,000 Jisa allowance is separate from an adult’s personal Isa allowance meaning those who pay into a child’s Junior Isa won’t be using up their own tax-free allowance.

However, for all its positives, parents and others need to be aware before saving or investing in a junior Isa that once the child turns 18, it becomes their money to do what they like with.

For those opting to save into a Jisa, the returns on offer are actually much better than adult cash Isa options. Check the best cash junior Isa rates in our tables.

There are fewer Jisa stocks & shares providers than for adult Isas. However, there is still plenty of choice.

Innovative Finance Isas

IFISAs let you use your tax-free Isa allowance to invest in peer-to-peer lending. These are typically loans that you give to other people or businesses without using a bank as a middleman, in return for interest.

However, anyone considering going down this route, should approach with caution and they are relatively niche.

Last year, the world’s oldest P2P lender, Zopa Bank closed down its P2P business returning all investments to its investors.

Funding Circle, the UK’s biggest P2P lender also took the decision to permanently close its retail platform for new investments.

There can also be complications surrounding liquidity were you needing to have the entirety of your investment returned.

IFISAs come in all shapes and sizes, lending money for individuals, small businesses, property developments, historical refurbishments, or renewable energy projects.

Some argue that this offers a good middle ground between cash and investing, with higher returns than cash and less volatility than stocks and shares.

However, a key issue is that money invested via an IFISA will not be eligible for FSCS protection up to £85,000 per individual unlike in a FSCS protected savings account.

If the company the P2P platform has lent your Isa cash to defaults on its loans you’re unlikely to get your money back. Therefore, if you decide to go down this route it’s essential to do your due diligence, spread your money around different investments and recognise you may be taking on higher risks than with traditional stocks and shares.