How to pick the Isa that’s right for you

There is an Isa for every saver, but it is not always easy to find out which one is right for you.

The Isa family has grown over the years and now there are five different varieties to choose from.

They’ve been around for 24 years, with several new additions along the way. All ISAs are designed to help you protect and grow your wealth. But each will help you with different purposes.

Build a rainy day fund

Cash Isas are perfect if you are growing a small nest egg or want a home for savings that you will need for years to come.

They work in much the same way as a standard savings account. You open an account, pay cash and get interest in return.

As with all savings accounts, some Cash Isa’s allow you to access your money whenever you want and without notice, while others lock your money away for an agreed-upon period of time.

The only major difference between Cash Isas and other savings accounts is that in the former, all interest earned is tax-free.

Cash Isas had fallen out of favor in recent years and savers were just as happy to put their money in a regular savings account.

That’s because they earned so little interest that few had to pay taxes anyway.

All savers have a personal savings balance on top of their ISAs. Savers who are base rate payers can earn up to £1,000 in interest without paying tax, while higher rate taxpayers can earn up to £500. For most this was enough.

But now that interest rates have started to rise, it’s much easier to go over the personal budget and Cash Isas are showing their value again.

For example, if a higher rate taxpayer deposits £20,000 into a standard savings account and pays three per cent, they could end up with a £40 tax bill. But if they save the same amount in a Cash Isa, they pay no tax.

Which Cash Isa is right for you depends on why you expect to need to withdraw your money.

If you need it immediately, an account with easy access is best. The best rates for this are currently just above three percent.

If you don’t need your money for a while, you might be better off with a fixed rate cash Isa, which locks your money in for a few months or years.

The longer you fixate, the better rate you’re likely to get.

However, the rewards for repairing for a few years are not much greater than for one or two, so you may not find it worth repairing any longer.

You can currently get a one-year fixed-rate bond that pays out more than four percent. The best five-year fixed rate ISAs today pay about 4.2 percent.

Looking long term to grow your wealth

Cash ISAs are great for money you want to access for the next five years. But if you can lock up your savings for at least five to 10 years, a Stocks and Shares Isa may be a better option.

In most periods, investing has proven more lucrative than earning interest on savings.

For example, if you had invested in a globally diversified portfolio of companies since 2005, you would have earned about 10 percent per year on average. If you had left your money in a savings account, you would have earned an average of about 1.5 percent per year.

However, investing requires a certain mindset. With cash savings you know exactly how much you have in the bank at any time.

When investing, the amount you have varies from day to day. You have to be able to accept that you could lose money and there is an element of risk involved.

Beth McCarthy, 31, an IT quality assurance manager from Gloucestershire, started investing through an ISA four years ago. “There are a few things I’m trying to accomplish,” she says. “I’m a saver and I like to know I have a nice pillow behind me just in case. I would also like to save for the next move, whenever that may be. And finally, I am building a comfortable life for my retirement.’

Beth opted for an Isa instead of a general investment account so she could hold onto more of her returns to accelerate the growth of her nest egg, rather than handing over a portion to the IRS.

You can open and manage a Stocks and Shares Isa through an investment platform or through a bank. Which one is best for you depends on how much control you want over what you invest in, which offers the best value and what level of customer service you need.

For an excellent overview of the options available on our sister website, This is Money, visit thisismoney.co.uk/platform.

Don’t be put off if you’ve never invested before. There are a growing number of options designed for novice investors. These do not require you to pick funds, make predictions about the economy, or buy and sell stocks. You simply indicate how much risk you are comfortable with and how long you can invest and you are assigned a portfolio that meets your needs.

If you are saving for your first home

A Lifetime Isa can help you boost your savings as you work towards purchasing your first home. There are two types: one keeps your savings in cash and the other invests it.

Lifetime Isas can be very generous for some savers. However, there are very strict restrictions.

Matilda Littler, 27, a project manager from Hertfordshire, opened a Lifetime Isa to help save for her first home. She gets a government bonus on top of anything she can save on her own.

“I’ve had my Lifetime Isa for about three years now and have received £3,000 as a government bonus,” she says. ‘I also benefit from an interest rate on my savings of 2.85 percent.’

Looking ahead to your retirement

Retirements are probably the best option for most people saving for retirement. With the occupational pension in particular, you benefit from both tax relief and contributions from your employer.

However, if you are self-employed and therefore do not have a company pension – or if you want to supplement your company pension, a Lifelong Isa can come in handy.

They are designed to support retirement savings, as the money saved in them can only be used for your first home or when you reach age 60.

Read our Lifetime Isa guide for more information.

Saving for your child’s future

Children can also have their own Isa. The Junior Isa (Jisa) can be opened from birth until a child turns 18.

Annual deposits are capped at £9,000 and funds are not accessible until they turn 18. It may seem strange to protect a child’s money from taxation, but they are subject to the same tax rules as adults.

Plus, if a parent deposits money into a child’s account and they earn more than £100 in interest, anything over £100 is taxed at the parent’s income tax rate.

By putting their savings into a Junior Isa you don’t have to worry about taxes today and as their nest egg grows you know it will always be tax free.

Junior Isas are automatically converted to adult Isas when the child reaches the age of 18.

You can choose from a Junior Isa in cash or an investment, or have one of each. Since the money is put away for the long term, Junior Isa offers the better growth opportunity for almost two decades.

“A big advantage of a Junior Isa is that any capital gains or dividend income on investments is protected from tax,” says Alice Guy, personal finance editor at wealth platform Interactive Investor.

“That could potentially save thousands over time, especially as a child grows up and starts paying their own taxes,” she adds.

For something different

The last member of the Isa family is the Innovative Finance Isa.

These accounts allow you to invest your Isa credit in peer-to-peer (P2P) lending. This means that your money is loaned to borrowers who pay it back to you in installments plus a fixed amount of interest.

An Innovative Finance Isa can offer much higher interest rates than a Cash Isa.

For example, Crowd2Fund advertises an annual return on its IF Isa of 11 percent.

But you take a lot more risk. You can lose your money if a borrower defaults.

These ISAs are not covered by the Financial Services Compensation Scheme (FSCS), which means that if the P2P company goes out of business, you may not get your money back.