When it comes to picking the right ISA for you, it can feel quite overwhelming with a number of different types to choose from. One of the common questions that people often ask is whether they should opt for a standard ISA (individual savings account), or LISA (lifetime individual savings account). The short answer is you can actually have both.
In fact, within any one tax year, you can contribute to four different types of ISA – a cash ISA, a stocks-and-shares ISA, a LISA and an IFISA (innovative finance ISA). Here we take a closer look at two particular types, to help you get a better understanding of the differences between ISAs and LISAs.
What is a cash ISA?
Cash ISAs allow you to save money in a tax-efficient way, as all income and capital gains are tax-free.
They’ve been around since 1999, but this type of ISA fell out of fashion for a while when the Personal Savings Allowance was introduced in 2016. With this allowance, basic-rate taxpayers could get £1,000 of annual interest before paying tax, dropping to £500 for a higher-rate taxpayer. For a time, ISAs were nudged out of the limelight.
However, rising interest rates have brought them back centre stage, as many more people are now paying income tax on their savings. As a result, cash ISAs have become popular – and important – once again.
These tax-free wrappers are great for storing money that you need to be able to access. Unlike a stocks-and-shares ISA, the value of your cash ISA will never go down. That said, it will be at the mercy of inflation. With this in mind, cash ISAs should be your first port of call if you are looking to build up a rainy-day fund, or if you are saving for the short term – and in need of the money in the next five years or so. But they’re not the best place to really grow your savings.
An easy-access cash ISA is likely to be a good choice for those who want quick access to their funds, whereas a fixed-rate ISA may be better suited to a saver looking for a guaranteed return of interest.
(For someone with medium to longer-term financial goals, with a time horizon of five years or more, a stocks-and-shares ISA may be a better option. While this does involve risk – as the value of your investments can go down as well as up – the key to remember is that small amounts saved regularly can grow substantially over time).
What is a LISA?
The lifetime ISA is a relatively new addition to the ISA stable, designed to help those aged under 40 save for a first home. It comes with the added bonus of a 25% top-up from the Government, meaning that if you put in the maximum £4,000 a year, you would get £1,000. You can choose between a cash LISA or a stocks-and-shares LISA, but before opting for any type of ISA, you need to be aware there are strings attached. You can only use a LISA to fund your first house purchase. Or, you can draw the money once you hit 60. Use the money for anything else, and will lose the bonus and face a penalty.
Further, the annual allowance for a LISA is frozen at £4,000, and there’s a cap on the value of the property you can purchase using LISA money – at £450,000. This cap has proved problematic in parts of the UK, and especially in parts of London and the south east.
When you’re trying to decide between cash ISA versus lifetime ISA, you need to decide what your goals are. In short, a LISA is only suited to those saving for a deposit for a first home – or for retirement.
You also need to be aware that LISAs come with age restrictions. You can only pay into a LISA if you are aged between 18 and 50. You also need to have set up the account by the age of 40. As a higher earner looking to build up funds for retirement, you need to think carefully before squirrelling money into a LISA. If you’re not currently maximising your employer contributions, you may be better off paying more into your pension.
Know your limits
One crucial thing you need to think about before paying into different types of ISA is ensuring you don’t breach the ISA limits. The overall contribution is set to remain frozen at £20,000 into the new tax year, while the maximum you can put in a LISA is £4,000. A LISA counts towards your £20,000 allowance.
So how might this work in practice? In any one tax year, you could, for example, pay £5,000 into a cash ISA, £10,000 into a stocks-and-shares ISA, £4,000 into a LISA, and £1,000 into an IFISA. Don’t forget that you either use that £20,000 annual allowance or lose it. When the new tax year begins, a new allowance comes in.
ISA rules are changing
From the start of the new tax year (6 April, 2024) the ISA rules are due to change as part of a simplification of the system. From this date, you will be able to open – and pay into – multiple ISAs of the same type in one year without losing your Isa allowance (with the exception of a Lifetime ISA). This means that even though the overall limit is frozen at £20,000, you will have more flexibility with regard to how you use your allowance. But you do need to track contributions carefully to ensure you don’t breach your allowance. Note that there have been no changes to the LISA.
Choose the right type of ISA for you
What you need to remember when weighing up cash ISAs versus LISAs is the fact the most suitable ISA for any saver will be down to their individual circumstances. Which ISA you choose will depend on your situation – how long you want to save for, and what your goals are. For more information on all types of ISAs head to the Government website, here.
Photo by Gio Bartlett on Unsplash
