ISA vs Savings Account - Which is Better?

Lots of us want to try to save more money, but how to do it is another question entirely. Most people will have heard of ISAs and savings accounts, but few seem to know the difference and what it means for their money.

In this guide, we explain the main features of ISAs and savings accounts and summarise all the key information you’ll need to make an informed choice about your nest egg.

What is an ISA?

What is an ISA?

Individual Savings Accounts (ISAs) are accounts that can be used to save money in a tax-efficient way. Every year, the UK Government sets a limit for how much money can be saved in ISAs without the income or interest being taxed. For the 2021 to 2022 tax year, the maximum amount individuals could save in ISAs was set at £20,000 – and you can check the current figures on the Government website here.

ISAs come in a number of different varieties, including:

  • Cash ISAs – which work in a similar way to a standard savings account, except that any interest earned is not taxed. This category covers a number of saving account types including Instant Access Cash ISAs, Notice Cash ISAs, Regular Savings Cash ISAs, and Fixed-Rate Cash ISAs
  • Stocks and Shares ISAs – which protect the income from various types of investments from tax.

ISAs generally work in a similar way, but they can come with their own rules, conditions, and bonuses that make it easier to save money.

What is a Savings Account?

A savings account is a bank account that you can use for the money that you don’t need to access immediately. They generally earn more interest than a standard current account, but you may be taxed on the interest you earn. Some accounts also make it more difficult for savers to access their money, and this can discourage you from dipping into your savings.

Some of the main varieties of savings accounts are:

  • Regular Savings Accounts – which allow savers to contribute money each month, up to a set limit. These accounts have reasonably high-interest rates, but they sometimes come with conditions that can make it hard to access your money right away.
  • Easy Access Accounts – allow you to withdraw your money whenever you want, without the need to pay a penalty. These accounts usually come with variable interest rates, which means that the bank can change them at their discretion.
  • Fixed Term Accounts – these accounts offer a fixed rate of interest, but do require you to save money for a specified period of time. If you wish to access your money before that time has elapsed, you may need to pay a penalty.

What’s the Difference Between ISAs and Savings Accounts?

What’s the Difference Between ISAs and Savings Accounts?

There are several key differences between ISAs and savings accounts that make them appropriate for different purposes. 

1.     Tax

The most notable difference between an ISA and a savings account is that they handle tax in different ways. Normally, any interest you earn on your savings is subject to income tax. Basic-rate taxpayers can earn a certain amount (currently £1,000) of interest per year before incurring income tax liability (for higher rate taxpayers the figure is currently £500). This is called the ‘personal savings allowance’. Any interest earned above this figure is considered taxable income.

ISAs are tax-free no matter how much interest you earn, but the amount you can save each year is limited.

2.     Deposit Limits

As mentioned above, the amount you can save in an ISA each tax year is limited. The current limit for annual ISA savings is £20,000.

In contrast, there is not usually a limit on how much you can put into a savings account unless your bank imposes its own restrictions.

3.     Account Limits

While you can open as many standard savings accounts as you want, you’re limited to opening one cash ISA each tax year. 

What ISAs Can Offer

The primary attraction of ISAs is that they offer a tax-efficient way to save your money up to £20,000. This means that savers can earn far more in interest without being taxed than would otherwise be the case if they only relied on the personal savings allowance.

The value of ISAs can also be passed onto a spouse or civil partner in a tax-efficient manner should the original saver die. This marks them out from ordinary savings accounts, but it does require the individuals involved to be living together at the time of death, not separated by court order, or not in a situation where the relationship has broken down.

What Savings Accounts Can Offer

Savings accounts are an easy and flexible way to save money. There’s no annual limit on how much you can put away, and the personal savings allowance means you can save up to a set figure without being taxed.

Notably, additional rate taxpayers do not qualify for a personal savings allowance. You’ll also need to pay income tax on any interest you earn over and above your PSA.

Should I Open an ISA or an Ordinary Savings Account?

As with any financial decision, the answer to this question really depends on your personal needs and goals.

If you’re aiming to save small amounts of money to reach a short-term goal, a savings account may be the better option. You’re unlikely to exceed the personal savings allowance, and it may be easier to access your money.

On the other hand, an ISA may be more appropriate for somebody who wants to save a larger sum of money. Any interest you earn will be tax-free, but access to your cash may be restricted.

Help to Save: Accounts for Low-Income Workers

Help to Save is a government-backed scheme that is designed to help people on low incomes save more money.

The scheme is only available to individuals who receive Working Tax Credit, are receiving Child Tax Credits, or are claiming Universal Credit and earned a minimum of £617.76 during their last assessment period.

Help to Save provides a bonus of up to 50% on any savings paid into the account up to a maximum of £1,200 over the account’s lifetime, with the extra money paid at intervals of two years. The account itself can last for up to four years and allows savers to put in between £1 and £50 each month.

Stocks and Shares ISAs (Investment ISAs)

A stocks and shares ISA offer a tax-efficient way to invest money for the future. Since it involves investing your money into stocks or shares, it does carry a level of risk that you wouldn’t need to accept with an ordinary ISA. Despite this, the potential returns are often much higher.

Investment ISAs allow you to invest money into shares, bonds, investment trusts, and other forms of exchange-traded investments. The money you earn will be protected against income tax and capital gains tax, and this includes any interest or dividends you earn.

The major risk with any form of investment is that you could get less money back than you put in. The level of risk associated with a stocks and shares ISA depends on the investments you make. Some are riskier than others, and it’s essential to conduct thorough research and take advice where necessary before deciding to deal in shares or any other form of investment.

Lifetime ISAs

A Lifetime ISA (LISA) is a type of account that can be opened by anyone aged between 18 and 39. They allow savers to contribute up to £4,000 each year to be used to purchase a first home or to fund retirement.

The major benefit of LISAs is that the government will add a cash bonus of up to £1,000 each year on top of the money you save. The bonus is calculated as 25% of whatever you save, and you can earn interest on your savings without incurring an income tax liability.

Annual ISA Allowance

An important feature of ISAs is that you can only save a certain amount in these accounts each year. The figure for 2021 to 2022 is £20,000.

You can transfer cash from a previous years’ ISA without it affecting your current allowance, provided that you transfer the whole amount.

You can only put money into one cash ISA and one stock and shares ISA, or one lifetime ISA during each tax year.

Conclusion: Different Accounts for Different Needs

ISAs and savings accounts are great ways to put money aside and to become more financially stable. While they both help individuals to save their cash, some key distinctions make these accounts suitable for savers with different goals.

If you’re trying to save towards a short-term goal and need to access your money quickly, a savings account may be more appropriate.

On the other hand, long-term goals are often better served by an ISA which allows you to save in a more tax-efficient way.

The important thing is the choose the right account for you, and to remember that saving money is a positive step no matter how much you have.

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