What is an ISA?

An individual savings account - ISA for short - lets you earn interest on cash savings or dividends from investments without paying any income tax or capital gains tax

To balance their tax-free nature, there's a limit placed on how much you can pay into them each tax year.

ISAs were introduced more than two decades ago to encourage people to save for their future.

What they offer and what they let you pay into has changed a bit over the years, but the core idea - allowing people to save for their futures without being hit by tax on returns - is still the same.  

How do ISAs work?

Every tax year, which runs from 6 April to 5 April the following year, you are given an ISA allowance that lets you save or invest money up to a certain amount without paying tax on your returns.

Your ISA allowance for the current tax year is £20,000. This means you have until 5 April to use up your ISA allowance for this tax year. 

If you miss this deadline, any money you pay into an ISA will count towards your ISA allowance for the following year.

How much tax do you save with ISAs?

You will not pay any income tax on money saved in an ISA, providing you don’t pay in more than your allowance each tax year.

If you are over-enthusiastic with your ISA deposits, HMRC will let you know what you owe in tax. The amount you would repay will depend on your tax-rate status, which for the current tax year is:

*After exceeding personal savings allowance of up to £1,000 in interest per tax year.

Who can open an ISA?

To be eligible to open an ISA, you need to:

• Be 16 or older for a cash ISA

• Be 18 for stocks and shares ISA or an innovative finance ISA

• Be the parent or guardian of a child under 18 to open a junior ISA

• Be 18 to 39 to open a lifetime ISA

• Be a resident in the UK (or a Crown employee if abroad)

An ISA can only be held in one person's name. It’s not possible to have an ISA in joint names.

What types of ISA are there?

There are two main types of ISA: cash ISAs and stocks and shares ISAs. There are also some specialist ISAs to choose from. Here’s how they work:

Cash ISAs

These work in the same way as conventional savings accounts, but with the tax-free wrapper. There are two basic types of cash ISA:

• Instant access: You can withdraw and deposit funds in accordance with the specific provider’s terms (some limit transactions)

• Fixed term: Your money is tied up for a fixed term, during which you receive a fixed rate of interest

Stocks and Shares ISAs

These are stocks and shares investment accounts that use your ISA allowance as a wrapper to make them tax efficient.

Your money is at risk as the value of stocks and shares can fluctuate, but over time you are likely to receive better returns than with Cash ISAs. Find out about how Stocks and Shares ISAs work here.

Specialist ISAs

• Junior ISA: for under 18s only, read this guide for further information

• Lifetime ISA: for adults under 40 saving for retirement or to buy their first home, read this guide to find out more

• Innovative finance ISA: Peer-to-peer investments with which you earn interest by lending money to individuals, businesses and property developers.

* some cash ISAs pay variable interest rates.

How do you open an ISA?

You can open an ISA in a branch, online, by post or over the phone, depending on the type of account and provider you choose.

You’ll need to put some money in when you open an ISA, meaning you’ll need funds available to cover the minimum amount, which can vary from £1 to more than £1,000.

You’ll need to give your personal details when you apply, including your:

• Name

• Address

• National Insurance number

You’ll need to read an ISA declaration, which tells you how ISAs work.

Read the application form carefully before signing, as it may include details of important restrictions such as withdrawal penalties.

What happens after you open an ISA?

You’ll be given a passbook, certificate or an online statement to view after you open your ISA.

When it comes to managing your account, you’ll need your passbook or certificate to make any withdrawals or changes to your account if you have a branch-based ISA. You can usually manage online ISAs via your computer, tablet or mobile phone.

How many ISAs can you have?

You can accumulate several ISAs over the years. And you can also consolidate your past ISAs by transferring them to your current ISAs if they offer more attractive terms.

However, you can only pay into one cash ISA, one stocks and shares ISA, one lifetime ISA and one innovative finance ISA in each tax year, and the total you invest across the three types of account must not exceed your ISA allowance – currently £20,000.

You can transfer to a new ISA within a tax year - but only if you take all the money you've already saved into the old ISA to your new one. 

If you have opened a junior ISA for your child, this is treated as outside your allowance (it’s your child’s account and their allowance, which is £9,000 a year currently).

Can you withdraw money from your ISA and put the money back later?

This depends on the terms and conditions of your ISA, so ensure you find out before opening a new ISA whether:

Your ISA is flexible

• You can withdraw money and pay it back in during the same tax year without it affecting your ISA allowance (eg if you deposit £5,000 then withdraw the same amount, you can still pay in a total of £20,000 this tax year)

• You can also withdraw any ISA money you have from previous tax years, and have until the end of the tax year to pay it back in to an ISA

In both cases, check the small print before doing anything as some ISAs limit the number of transactions you can make. As not all ISA providers allow transfers, you should also check the T&Cs before making a withdrawal. 

Your ISA is not flexible

• Any money you pay in then withdraw will still count towards your remaining ISA allowance (eg if you pay in then withdraw £5,000, you can only deposit up to £15,000 for the rest of this tax year).

• Deposits that exceed the allowance will generally be rejected

Your money will also lose its tax-free status if you withdraw it and pay it into a normal savings account.

Can you transfer an ISA?

You may want to move holdings in a previous year’s ISA to a new one if the rate of return is better.

This is allowed under the rules; just don’t attempt a transfer until you’ve checked whether your new ISA allows transfers in. 

To retain your tax advantages, you need to transfer your ISA directly from one provider to another. 

This way, you won’t lose the ISA allowance you had already built up in an old ISA or affect your current year’s allowance. So if you move £20,000 from an old account to a new cash ISA, you’ll still have up to £20,000 to deposit before the end of the current tax year.

If you want to transfer your ISA to another with the same provider, you can also ask to do an ISA consolidation, which lets you combine ISAs together into a new or existing ISA.

However, if you try to move your ISA by withdrawing the funds, you will lose its ISA status, as it’s no longer within the tax-free wrapper.

What happens to your ISA when you die?

When you die your ISA becomes part of your estate and loses its tax-free status, meaning it’s liable to income tax, which will affect what your beneficiaries get. 

The exception is if you leave behind a spouse or civil partner. In this case, they would see an amount equivalent to your ISA savings or investments added to their current year’s allowance, tax-free. 

For example, if you die leaving £50,000, your spouse or civil partner would receive a one-off extension to their annual allowance of this sum, giving them a total allowance of £70,000 to invest as they see fit. 

Even if you leave your ISA to somebody else in your will, such as your son or daughter, your spouse or civil partner will still benefit from the £50,000 additional ISA allowance.

What protection does your ISA have?

The Financial Services Compensation Scheme (FSCS) protects the first £85,000 of any cash or investments held in ISAs with each separately registered institution. 

To qualify, your ISAs must be in a financial company, such as a bank or investment house, that’s regulated by the Financial Conduct Authority (you can check whether yours is here).

If you have more than £85,000 in savings with one institution, or two sister companies in the same group, you could end up out of pocket should the group go bust as the FSCS only guarantees a payout of £85,000.