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ISAs: What are they and which one should I get?

Close-up of British currency
COVID has shown us now more than ever the importance of having emergency funds. Photo: Peter Dazeley/Getty Images

The COVID-19 pandemic has shown the importance of having savings as a lifeline in unpredictable circumstances. According to comparison website Finder, one in 10 Brits have no savings at all, and a third of the population has less than £600 saved.

ISAs are individual savings accounts which support you on your journey to keeping more money in your pocket, because they are tax-free, unlike other savings accounts where you pay income tax on the interest you earn. There are four main types of ISAs – cash, stocks and shares, innovative finance, and lifetime – and in the 2021-2022 tax year the allowance for ISAs is £20,000.

Each one has specific purposes for saving. So which ones are on offer and which one might be right for you?

Cash ISA

With a cash ISA, your savings are tax free, so all the interest you earn from the bank is kept by you.

Instant-access ones allow you to take out your money whenever you need it, with lower interest. By contrast, fixed-rate ISAs attract higher interest but do not allow you access to your money during that fixed term, or you will lose interest. So the longer you keep your money tied up, you can save a lot more over time.

You can only have one active cash ISA per year – you cannot open several to claim interest from depositing money into each of those.

Watch: How to save money on a low income

Stocks and Shares ISA

You pay no tax on any dividends, growth, interest or income you get from the investments, and, as with the cash ISA, you can only open one of these, with one ISA provider, during a tax year and need to be at least 18 years old.

Be aware of the risks – low-risk investing tends to focus on bonds that return regular dividends and interest, so there is more security, whereas high-risk investing tends to focus more on the stock market.

As ever, remember that the value of your investments can go both up and down, so there is a chance you get back less than what you first put in. For this reason, it is not advisable to get this ISA if you have debt or no other savings.

Innovative Finance ISA

With these, the income you get from "peer-to-peer lending" is tax-free, and peer-to-peer means you are lending money directly to an individual or business through an online platform, with no bank in-between. To be offered one, you need to be approved by HMRC as an ISA manager and they are only available to investors aged 18 or above.

There is a risk with this as borrowers can default on their loans, meaning they stop paying you back, so again it is not advisable to open this kind of ISA if you already have debt and no savings.

Again, you can only open one of these in one calendar year.

A trader looks at screens of financial data
The value of your investment can go down as well as up. Photo: Daniel Sorabji/AFP via Getty Images

Lifetime ISA

This can be used to buy your first home or save for later life. You have to be aged 18-39 to open a lifetime ISA.

Up to £4,000 each year can be put in, until you turn 50 and your first payment into the ISA has to be before you turn 40. The government will add a 25% bonus to your savings, which is up to £1,000 maximum per year.

The £4,000 limit counts towards your annual ISA limit – £20,000 for the 2021 to 2022 tax year.

The Lifetime ISA gives you the choice to hold just cash, or stocks and shares in it, or a combination.

You can withdraw from the account for buying your first home, if you are 60 or over or terminally ill, with less than 12 months to live. Any other reason is known as an unauthorised withdrawal and will incur a withdrawal charge of 25%. This matches the government bonus of 25%.

A couple hug after buying their own home
The Lifetime ISA, or LISA, can also be used towards buying your first home. Photo: Getty Images

Help-to-Buy ISA

Although this one isn't on offer any more, existing account holders may need a reminder of the details.

This one is only for first-time buyers, and for residential homes – you cannot use it to purchase a buy-to-let property. If the house you're looking at is in London you can use the Help To Buy ISA for homes worth up to £450,000, and if it's outside London the maximum value of the home you can buy is £250,000.

You can put up to £200 in per calendar month, and the interest from your bank will be added to your account.

The minimum you need saved before you can claim your government bonus of 25% is £1,600 by the time you are ready to buy a house.

The maximum government bonus is £3,000, which you get if you have £12,000 saved.

Accounts are limited to one person but not one home, so if you wanted to buy a house with someone who also has a Help-To-Buy ISA, you can do that and both get the bonus of up to £6,000.

The money you have saved can be used for the deposit, but the government bonus cannot be used at this point because it is paid after the contracts go through and the transaction is confirmed.

The government bonus also cannot be used to pay your solicitor’s or estate agent’s fees – this goes towards towards the cost of actually buying the house.

As with all of these ISAs, make sure you speak to your bank about the details so you are aware of how each one would work with your specific needs.

Watch: Should I pay off debt or save money during the coronavirus pandemic?