Saving whilst interest rates are low – ISAs explained

Piggy bank

The combination of inflation and low interest rates has continued to discourage Brits from saving. The savings ratio – the amount households save out of their income – dipped to 5.2%, the second lowest level in 20 years.

ISAs explained

It’s easy to see why. If you’ve got spare cash in your pocket, would you rather splash out on something you really want or save the money knowing you won’t earn much interest?

But, even though now might not be the easiest time to save, there are good reasons to continue putting money away each month. Let’s take a look.

An ISA is nicer – protect your savings from the tax man 

Instead of concentrating on current low interest rates, focus on the reasons why saving remains worthwhile. A good starting point is to think about your long-term financial objectives and how saving could help you achieve them. Do you want to get on the property ladder, for example, or are you working towards a new car?

ISAs are savings or investment accounts with tax incentives, set up by the government and offered by many financial institutions. Each year, you can put in up to a maximum limit (£20,000 in 2017/18) and any interest you get will be entirely free from income tax and Capital Gains Tax (CGT).

There are different types of ISAs depending on your needs and goals: cash ISAs, stocks and shares ISAs, innovative finance ISAs, Lifetime ISAs and Help to Buy ISAs. You can open one of each kind in a tax year, but can only save a total of your maximum annual allowance across all of them.

Even if you only have a few pounds to put away, saving regularly can help you reach your goals faster. Plus, any interest you earn will also earn interest – known as ‘compound interest’ – which will add up over time.

How do ISAs stack up against regular savings accounts?

In April 2016, the government introduced a tax-free personal savings allowance (PSA) of £1,000 (£500 for higher rate taxpayers) for savings income or interest. Before the introduction of the PSA, tax of 20% was automatically deducted from your savings income - the only exception being if your money was in an ISA.

While the PSA is positive for savers, ISAs allow you to save more tax-free and over a long period of time. Once your money is in one, it’s safe from the taxman.

However, to make the most of the benefits, it’s worth saving as much as you can into an ISA each year. Every 6th April sees your allowances re-set; you can’t invest anything into previous years’ pots of money, and you’ll be bound by this year’s maximum amount.

Types of ISAs explained

It’s important to choose the right type of ISA for your needs; if you’re in any doubt speak to a financial advisor.

  • Cash ISAs. These are tax-free savings accounts. They tend to offer the lowest interest rates, but if you lock your money away for an agreed period of time (usually two or three years) you will benefit from a slightly higher rate. Cash ISAs can also be flexible: if you withdraw money, you can replace it within the same tax year without affecting your annual allowance.
  • Stocks and shares ISAs. These invest in the stock market: you choose your provider and which funds you want to invest in. They are subject to usual market risk and fluctuations so, although they may end up offering higher returns in the long run, you could also end up losing some or all of your investment.
  • Innovative finance ISAs (IFISAs). Introduced in April 2016, these allow you to get tax-free interest on peer-to-peer lending. As with stocks and shares ISAs, interest rates can be higher than standard cash ISAs. However, as this is peer-to-peer lending it’s not covered by the Financial Services Compensation Scheme. This means, if the company goes bust, you could lose your money.
  • Lifetime ISAs (LISAs). If you’re under 40, this is an option to help you save towards your first home or retirement. Launched in 2017, you get a 25% bonus on annual savings up to £4,000 per year, until you’re 50 years old. However, if you withdraw the money for any other reason than retirement (aged over 60) or to buy your first home, you’ll be charged a penalty. Don’t forget, as the LISA is only £4,000 a year, you can put the remainder of your annual allowance into other ISAs.
  • Help to Buy ISAs. Specifically designed for those who want to save for their first home, this ISA has no upper age limit and lets you save £200 a month – plus £1,200 in the first month - rewarding you with a 25% bonus when it comes to buying your home. However, there are restrictions on the maximum value of the house you can buy and you have to be a first-time buyer.
  • Junior ISAs. If you have children under 18 years old, this is a tax-efficient way to save for their futures.

Although low interest rates may not be good news for savers right now, this doesn’t make putting money aside for the future any less important. Setting up a standing order so an affordable amount goes into an ISA each month can be one the best ways to start the savings habit – once it’s in place, you may not even notice the shortfall in your monthly budget. Plus, as soon as you see the value of your ISA rising, you might even be spurred on to reach your financial goals even sooner.


  • anthony-hua-updated

    Anthony Hua, Editor

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