ISA stands for “individual savings account”. These are special accounts that have a limit on how much money you can deposit into them each year but also come with tax advantages, which make them one of the top choices for specialized savings accounts.
A cash ISA is a savings account that exempts you from having to pay income tax on any interest earned. The limit on the amount you are allowed to contribute from tax year to year may change based on inflation.
There are several advantages to having a Cash ISA. First of all, your tax savings may be significant.
You can even transfer money into a new Cash Individual Savings Account from an old one in order to take advantage of competitive rates.
They allow you to save significantly more than a standard savings account, especially if you stay updated on the competitive ISAs available.
Keep in mind that ISAs come with caps and you cannot save more than your yearly allowance.
If you decide to withdraw money, that money does lose its tax-free status, so be careful when transferring funds into a new account.
Stocks and Shares ISAs
Stocks and Shares ISAs allow you to buy shares and bonds, and take greater risks with your money. They can be excellent options when saving for long-term goals that would allow your money to grow over a long period of time.
Like Cash ISAs, Stocks & Shares ISAs have annual allowances, although you may split a certain percentage between them and Cash ISAs.
Stocks & Shares ISAs outperform regular bonds and savings accounts over a long period of time, but there is always risk involved. The money held in your individual savings account is not subjected to taxation, meaning that you can generate substantial tax benefits whilst holding an ISA. If you understand how investments are normally taxed, you’ll appreciate how valuable a tax shield can be against those personal taxes.
On the downside, your investment can go through periods of rising and falling as with any stocks and shares options.
Despite the risks, Stocks & Shares ISAs can benefit anyone wanting to diversify their portfolio. This helps cut down on the risks associated with having all your eggs in one basket, so to speak.
Innovative finance ISAs
Innovative Finance ISAs are a new breed of ISA launched in the last few years which I haven’t covered in this article. To learn more, visit LookingAfterYourPennies.com for an overview of this complicated (but potentially lucrative) savings account.
You probably won’t find much reference to IFISAs in modern investing books unless they were published after 2018.
Mixing and matching
Having both a Cash ISA and a Stocks & Shares ISA will benefit anyone required to pay income tax.
Keep in mind, however, that withdrawing money from your ISA will cause you to lose that tax-free status, so have other savings accounts available for emergencies.
Be mindful of any restrictions and advantages when opening an ISA of any kind and take full advantage of those annual limits to maximize your opportunity to save money. This makes them ideal choices for long-term investing.
Consider beginning one of our free investing courses to learn more about your options.
Enjoying this article? To read more about stocks & shares, check out our ranking of the best stocks & shares books.