ISA or Savings Account: Which Is Best For Me?
The answer to whether you should open an individual savings account or a traditional saver depends on your income tax, and how much and how long you plan to save.
ISAs have been protecting our money from tax for more than 20 years now. But the arrival of the personal savings allowance and low interest rates mean traditional savings accounts can still look attractive. Here we explain the differences between the two.
What is an ISA?
Individual savings accounts (ISAs) allow you to save a set amount each year to grow tax-free for as long as it remains in the account. The amount you can save in an ISA is called your ISA allowance, and it currently stands at £20,000 a year (2020/21).
The easiest way to think of a cash ISA is to imagine it as a wrapper around a savings account protecting it from tax.
What’s the difference between ISAs and savings accounts?
There are a number of differences between ISAs and ordinary savings accounts.
The key difference between an ISA and a savings account is the tax you pay on your returns. When you earn interest on your savings it is liable for income tax. Basic-rate taxpayers can earn up to £1,000 interest a year before income tax is due, and higher rate taxpayers can earn up to £500. This is known as the personal savings allowance. If you earn more interest than that, it will be taxed.
In contrast, ISAs are completely tax-free regardless of how much interest you earn.
2. Deposit limits
You can put as much money as you like into a savings account, unless there is a limit imposed by the bank or building society.
In contrast, you have an ISA allowance that limits how much you can pay into ISAs each tax year. It is currently £20,000.
3. Account limits
You can only open one cash ISA each tax year, but you can open as many savings accounts as you like.
Should I open an ISA or an ordinary savings account?
The answer to this really comes down to how much money you want to save and how long you plan to save it.
If you are saving small amounts for a short-term goal, then a savings account will likely be the better option as it’s unlikely that you will exceed the personal savings allowance.
Anyone who is looking for a home for a large amount of money, though, should consider an ISA. With an ISA you never have to worry about your interest exceeding the personal savings allowance. It will always be tax-free.
Similarly, if you are saving for a long-term goal, then putting your money into an ISA means it remains sheltered from tax as it grows.
Ruth is a freelance journalist with 15 years of experience writing for national newspapers, magazines and websites. Specialising in savings, investments, pensions and property. Read more