What ISAs are
An Individual Savings Account (ISA) is a tax-efficient wrapper for savings and investments. Money held in an ISA is protected from income tax (on interest and dividends) and capital gains tax (on investment growth). This makes ISAs more tax-efficient than equivalent savings accounts or investment accounts outside the ISA wrapper, particularly for higher-rate taxpayers.
Types of ISA
Cash ISA: functions like a savings account but with the tax-free wrapper. Returns are typically similar to comparable savings accounts. Suitable for short-term savings or emergency funds. Stocks and shares ISA: holds investments (funds, shares, bonds, ETFs) within the tax-free wrapper. Historically outperforms cash over periods of five years or more, but with volatility. Suitable for medium to long-term savings. Lifetime ISA (LISA): for adults under 40, available for first-home purchase or retirement. Government adds 25% on top of contributions (up to £4,000 per year, so maximum £1,000 bonus per year). Innovative Finance ISA: holds peer-to-peer lending investments; higher risk and less popular since the P2P sector contracted.
The annual allowance
The ISA annual allowance is £20,000 (2024-25 tax year). This can be split across different ISA types (e.g. £10,000 in a cash ISA and £10,000 in a stocks and shares ISA) but the total cannot exceed £20,000. The allowance resets on 6 April each year; unused allowance from previous years cannot be carried forward.
Choosing the right type
For emergency fund / short-term savings: cash ISA (instant access). For a house purchase within 2-10 years and under 40: LISA (25% government bonus is extremely valuable). For long-term wealth building (10+ year horizon): stocks and shares ISA, typically holding low-cost global index funds. For those nearing retirement with existing pension coverage: stocks and shares ISA for flexibility (no compulsory drawdown age, unlike pensions).