ISA vs savings account: Which is best for you?

Here, we look at the main differences between different types of accounts to help you decide which might be best for you.  

The advantages and disadvantages of savings accounts and ISAs 

• ISA advantages: You do not pay tax on interest, dividends or investment returns on money held in an ISA – which can boost a nest egg significantly over a lifetime.
• ISA advantages: Some ISAs come with additional government perks such as the Lifetime ISA’s 25% bonus and the Junior ISA providing a separate allowance for helping under-18s save or invest.
• ISA drawbacks: There is a £20,000 limit on how much you can put into ISAs in a single tax year. Some accounts have lower limits, for example you can save up to £,4000 annually in the Lifetime ISA and £9,000 in a Junior ISA.
• Savings account advantages: People who have used up their £20,000 ISA allowance for the tax year could put any surplus into a general savings account.
• Savings account disadvantages: Depending on personal circumstances there may be tax to pay on interest received from savings in non-ISA accounts.

The basics: What is an ISA?  

An Individual Savings Account is an account that allows people to save money and not pay any tax on interest, dividend income or capital gains that their money makes. 

Some ISAs have other incentives to help people save for a first home, their children’s future or for investing in niche areas – more on this below. 

ISA accounts are either cash or stocks and shares. You can open one or more of each during your lifetime, but you can only contribute to one of each type in any given tax year. The different ISAs are listed below. 

• A cash ISA: is for keeping your savings in cash, which may earn interest. 
• A stocks and shares ISA: gives you the opportunity to invest in stocks and shares, or hold a portfolio of funds. Nutmeg offers a stocks and shares ISA and, while you can access your money whenever you want, we recommend that you intend to keep the investments for at least three to five years.  

The basics: How do general savings accounts work? 

General savings accounts don’t come with any government or HMRC perks. Instead, they’re straightforward: you put money in the account, build up a nest egg and they may earn interest over time.  

A similar account – without the tax benefits – exists for investments, known as general investment accounts.  

Personal Savings Allowance 

You may have to pay tax on any interest earned through a general savings account above the annual allowance. For the 2022/23 tax year, the personal savings allowance for basic rate taxpayers is £1,000 and for higher rate taxpayers it’s £500.  

For general investment accounts, you may have to pay tax on dividends or investment returns above the dividend or capital gains tax allowance.  

What are the different types of ISA? 

Alongside the tax benefits, ISAs also come in several versions, which the government has devised to help people save or invest for different reasons:  

• Junior ISA: Parents or guardians can open one of these for a child under the age of 18 and deposit up to £9,000 a year. The money is held in the child’s name and is legally theirs. Withdrawals are not allowed, except in special circumstances, until the child turns 18, when the account turns into an adult ISA. From that point, the youngster can spend, save or invest as they please. 
• Lifetime ISA: Can be opened by people aged 18 to 39 intending to save for a first home worth up to £450,000 or retirement. Deposits of up to £4,000 a year can be made until the age of 50 and receive a 25% government bonus each tax year. However, most withdrawals for a reason other than a first home of £450,000 or less or after you’ve turned 60 or have a terminal illness will be subject to a 25% government penalty, so you could get back less than you put in.  

Both of these come as stocks and shares ISA and cash options.  

• Innovative Finance ISA:  For UK adults over 18 looking to invest in niche areas such as peer-to-peer lending. 

Bear in mind that tax rules can change in future, and so can interest rates! Tax is also dependent on each individual’s specific circumstances.

How much can I contribute to an ISA?  

Each person has an annual ISA allowance of £20,000 that they can save or invest in an ISA for the 2022/23 tax year. 

For many people it is best to save the maximum amount each year in ISAs before putting additional savings into savings accounts.  

You can save up to the limit each tax year in one kind of ISA or spread it across the different kinds. The Lifetime ISA has special rules – you can save a maximum of £4,000 each year.  

What are the best interest rates on savings accounts? 

Comparison sites such as Money Saving Expert, Money Supermarket and others display the market leading interest rates currently available. Typically, locking up your money for a period of time can mean receiving higher rates of interest. 

Bear in mind that account providers can change interest rates at any time unless the rate was fixed at the outset for a set period. Check the rates being paid on your existing accounts and see if the money could be transferred to an account with a higher rate

Both general savings accounts and ISAs can be either: 

• Easy access – money can be withdrawn at request, although there may be daily limits to how much you can take out. Our colleagues at Chase are currently offering 1.5% interest on balances of up to £250,000 in their savings account. 
• Fixed-term – you deposit a lump sum at the outset for a set period, agreed in advance, usually one, three or five years. Withdrawals before the fixed term is up, are either not allowed or only with an accompanying penalty charge. 
• Notice accounts – you can request a withdrawal any time, but the provider needs time before it can return the money. The length of time is often 30-90 days and is agreed when you open the account. 

Who can open an ISA?

You must be a UK resident for tax purposes to open an ISA. There are also age limits for each kind of ISA. You must be: 

• 16 or over for a cash ISA 
• 18 or over for a stocks and shares or Innovative Finance ISA 
• Over 18 but under 40 for a Lifetime ISA 
• Under 18 for a Junior ISA, opened by a parent or guardian. 

Read more: Our ISA calculator can show you how much you could make through investing in a stocks and shares ISA. 

Who can open a savings account? 

You do not have to be tax resident in the UK to open a savings account. Some accounts may have age restrictions.  

Is my money safe in an ISA? 

It’s important to note that savings held in any ISA or savings account with a UK-regulated bank or building society are likely to be protected, so you will be reimbursed if the institution goes bust. 

There’s a limit of £85,000 per person, which is usually guaranteed by the Financial Services Compensation Scheme. 

What happens if I take money out of my ISA?

This depends on the kind of ISA account. For most ISA accounts you can withdraw the money when you want to – although for a stocks and shares ISA we recommend investing for at least three years and preferably longer. For most ISAs, once you have withdrawn the money you have used that portion of your ISA allowance for the year, so you will only be able to add more if you still have unused ISA allowance. For example, if you have put £18,000 into an ISA in the current tax year and you withdraw £4,000, you are only able to contribute a further £2,000 in the current tax year – as this will take you up to your £20,000 annual ISA allowance.

With the Lifetime ISA you cannot usually withdraw the money without paying a penalty charge unless it’s to put towards the purchase of a first home or for spending in later life, after you’ve turned 60.

The Junior ISA also bans withdrawals before the account holder turns 18, except in special situations.

Open an ISA with Nutmeg 

At Nutmeg, we help our clients buy their first home, invest for their retirement and achieve their financial goals. Start investing in your future today by opening one of our award- winning* stocks and shares ISAs, Lifetime ISAs, or pensions. We also offer a Junior ISA for your children. 

Simply answer a few questions so that we can determine your risk profile and we will match you to a globally diversified portfolio built by our expert in-house investment team. There are no set-up, transaction, trading or exit fees.

*Winner of the following Boring Money Best Buy and Best For Awards 2022: Best Buy ISA, JISA, LISA and Pension. Best for Customer Service and Best for Sustainable Investing. 

Risk warning  

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Tax treatment depends on your individual circumstances and may be subject to change in the future. 

Nutmeg is authorised and regulated by the FCA in relation to certain investment services and restricted advice only. Chase is a trading name of J.P. Morgan Europe Limited. Nutmeg is an affiliate company of J.P. Morgan Europe Limited. Before applying, you should consider if a Chase account and its features are suitable for you and your banking needs.