If you are looking for a smart way to save or invest, setting up an ISA could be an excellent option for you and your finances. ISAs are straightforward to understand, offer access to your funds, and the money you accumulate is tax-free. 

Before tapping into these fantastic benefits, get to grips with all there is to know about ISAs with our comprehensive, up-to-date guide. We’ll cover everything you need to know about ISAs: what they are, the different types available in the UK, how they work, and the pros and cons to help you make an informed decision. We’ve also included a helpful glossary to clarify unfamiliar terms or jargon. 

Your Guide to ISAs

What is an ISA?

An ISA (Individual Savings Account) is a tax-efficient way to save or invest your money in the UK. Any income or capital gains earned within an ISA are entirely tax-free, and you won’t pay tax on withdrawals either. 

The government introduced these tax-savvy ISAs in April 1999, replacing earlier schemes like Personal Equity Plans (PEPs) and Tax-Exempt Special Savings Accounts (TESSAs). Nowadays, they are one of the most efficient ways to save money. In fact, according to the Bank of England, savers deposited a record £11.7 billion into ISAs in April 2024 – the highest monthly inflow since ISA records began. 

What are the Benefits of an ISA?

The main advantage of an ISA is the ability to save or invest tax-free. With limited opportunities to reduce the amount of tax you pay on your hard-earned cash, an ISA can be a wise financial choice. Some ISAs offer instant access to your money, making them ideal for short-term financial planning. On the other hand, if you have long-term savings goals, you can lock your cash away for a fixed term or invest in an Investment ISA.

How Much Can I Pay Into an ISA?

There is a limit to how much you can pay into ISAs each tax year, known as your annual allowance. Paying into an ISA is known as subscribing. The government limits how much you can save each financial year in ISAs. For the 2024/25 tax year, you can deposit up to £20,000 across all the ISAs you hold, although each type of ISA may have its own annual contribution limits. 

The tax year runs from 6 April 2024 to 5 April 2025. You have until midnight on 5 April 2025 to use this allowance. You cannot carry your allowance over to the next tax year. However, a new annual allowance will be available from 6 April 2025. For example, if you’ve reached the £20,000 limit in the 2024/25 tax year, you can put another £20,000 away on or after 6 April 2025.  

What is the Difference Between an ISA and a Savings Account? 

Savings accounts are another popular way to grow your money. Banks and other financial providers offer these deposit accounts, allowing you to store money securely while earning interest. Common types of savings accounts include: 

• Easy Access Accounts
• Fixed Term Accounts
• Regular Savings Accounts 

Unlike ISAs, savings accounts have no annual deposit limit, so you can save as much as you like. However, if your interest exceeds the *Personal Savings Allowance (PSA) threshold, it may be subject to tax. The main advantage of an ISA is that all interest and gains are tax-free, which can offer better value for money than a standard savings account.

ISAs vs Savings Accounts at a Glance?

What types of ISA are avilable?

There are four main types of ISA, but not all financial providers will offer each type. These include:

• Cash ISA
• Stocks and Shares ISA
• Innovative Finance ISA
• Lifetime ISA

Different types of ISAs can help you achieve different savings goals. Let’s explore each option in detail below.

Cash ISA 

Many banks and building societies offer Cash ISAs. These ISAs give you tax-free interest on a fixed or variable rate and don’t count towards your *Personal Savings Allowance (PSA). Cash ISAs could be great for your short-term savings goals, as they are not linked to the stock market. You might consider using a Cash ISA as your ‘emergency fund’ to cover unexpected expenses or save towards a holiday.

Stocks and Shares ISA

A Stocks and Shares ISA is a tax-efficient way to invest money in shares, government bonds (gilts), and property with the peace of mind that you won’t pay any capital gains tax or income tax.  If you are looking to open a Stocks and Shares ISA there are two different options available: DIY and managed. 

• DIY: The DIY option means you’re responsible for selecting and managing your own portfolio of stocks, shares, bonds and other financial assets. It can be beneficial for experienced investors and those who enjoy active involvement in their investments. You may encounter platform fees, fund charges, trading charges and exit fees.
• Managed: Managed Stocks and Shares ISAs offer a more hands-off approach, where your portfolio is selected and managed on your behalf by a provider. You can find Stocks and Shares ISAs managed by automated 'robo-advisers' or real-life experts. Management fees are charged for the work they carry out. At Sheffield Mutual, our Stocks and Shares ISAs are actively managed by professionals. 

With both investment options, your capital is at risk. However, the managed investment does come with the expertise and experience of professionals which can give new or ‘hands-off’ investors peace of mind.

Choosing Between a Cash or Stocks and Shares ISA:

A Stocks and Shares ISA might be more suitable for your longer-term goals as they have the potential to outperform cash ISAs over the medium-long term. However, there are different risk levels.

When choosing between a Cash ISA and a Stocks & Shares ISA, we recommend considering four key factors: 

• The length of time you plan to save or invest
• Your tolerance for risk
• The impact of inflation on your savings
• Your need to access funds (Stocks and Shares ISAs may have withdrawal restrictions, the value can fluctuate, and accessing your money may take longer than with a Cash ISA)
  
  

Save with Sheffield Mutual's Stocks & Shares ISA

At Sheffield Mutual, we offer two different forward-thinking Stocks and Shares ISAs.

Investment ISA: 

One option is our medium to low-risk Investment ISA, ideal for individuals needing more extensive investment experience but wanting to make their money work harder. 

We’ll pool your money with all our other members to provide you with a potentially better return than what you might find on the high street. It is part of the **Financial Services Compensation Scheme (FSCS), and Sheffield Mutual’s with-profits fund uses  ***‘smoothing’ to protect your investment from short-term ups and downs that are usually associated with investing in the stock market. This smoothing process has enabled us to maintain stable bonus rates even in periods of volatility. Please note, as with any investment, your capital is at risk.

The current interim bonus rate is 5.75% (before a 1.25% management charge). Bonuses are not guaranteed and depend on the performance of the with-profits fund. There is also the possibility of a final bonus upon closure of the ISA. 

Sustainable ISA: 

Another option is our medium to high-risk Sustainable ISA. The fund has strong Environmental, Social and Governance (ESG) characteristics, is net-zero aligned, and is signed up to follow the Principles for Responsible Investment (PRI). 

The Sustainable Fund lets you invest in a highly diversified investment of asset classes, such as equities, bonds and cash. Since different asset classes perform well at different points in time, investing in a wide range of asset classes can help limit the extent to which the value of your investment fluctuates. For example, if one investment performs poorly, you still have the others to help balance it out. 

Our active management within the fund generates additional returns through individual manager selection and adjusting the asset mix to suit market conditions. However, please be aware that even a carefully managed, well-diversified fund can fall in value, and you may get back less than you put in. Capital is at risk.

Any money you pay is invested in our unit-linked sustainable fund and is overseen by our investment managers with a charge of 1.17%. You may want to consider this ISA if you are willing to take a higher risk for a potential greater reward. Again, it is part of the FSCS.

Innovative Finance ISA

An Innovative Finance ISA (IFISA) is a type of investment account which allows you to lend your money through peer-to-peer lending platforms to receive tax-free interest and capital gains. You could be lending money to serve personal loans, small business loans, property loans or a combination of these.

While interest rates can appear more attractive than Cash ISAs, peer-to-peer lending is a higher-risk form of investing. Be aware that your capital is entirely at risk, and there is no protection from the FSCS.

Lifetime ISA

Lifetime ISAs were launched in 2017 to help people save for their first home or retirement. If you're between 18 and 39, it’s a great way to work towards these financial goals. You can hold cash in a Lifetime ISA or choose to invest it, just as you would with a Stocks & Shares ISA. You can put in a maximum of £4,000 each year up to and including the day before your 50th birthday, but remember that this £4,000 counts toward your overall yearly ISA allowance (£20,000).

What makes the Lifetime ISA special is that the government will pay a 25% bonus on your contributions. For every £4 you save, the government adds £1, up to £1,000 annually. This initiative can go a long way in boosting your savings, yet there are crucial conditions to be aware of. While you can withdraw money from your Lifetime ISA at any time, a 25% withdrawal charge applies if you take cash out for any reason other than:

• Buying your first home.
• Turning 60.
• If you’re diagnosed with a terminal illness

If you withdraw for any other reason, you could lose the government bonus and part of your original contributions. Therefore, consider your savings goals carefully before opening a Lifetime ISA.

Can I Set Up an ISA for My Child?

Yes, you can set up a Junior ISA (JISA) for your child. A JISA works similarly to an adult ISA, allowing you to save tax-free on behalf of a child. Here are a couple of things to note:

• Children under the age of 18 who do not have a Child Trust Fund (CTF) account (available to eligible children born on or between 1 September 2002 and 2 January 2011) can have a Junior ISA (JISA).
• If your child does have a CTF, you can seamlessly transfer the funds into a Junior ISA.
  
  

Junior ISAs

Two types of Junior ISAs are available for children: Cash Junior ISAs and Stocks and Shares Junior ISAs. You can open one or both types for your child. Each child has an annual allowance of £9,000. The child’s parent or guardian must open the account, but anyone can contribute once it’s open. Your child can only access the ISA once they turn 18, and the proceeds will be tax-free. 

Since the money in your child’s Junior ISA legally belongs to them, their £9,000 annual allowance does not affect your £20,000 ISA limit. So, even if you’ve reached your annual allowance, you can continue putting money into a Junior ISA for your child’s benefit.

Give Your Child a Financial Headstart with Our Investment Junior ISA

Sheffield Mutual provides a medium to low-risk Investment Junior ISA, which offers tax-free returns and a capital guarantee on any money invested over five years. The current interim bonus rate on our JISA is 6.00% (before charges of 1.25%). Note that bonuses are not guaranteed and depend on the performance of the with-profits fund. 

As a mutual, we don’t have any shareholders to pay, so all surplus profits are shared with our members. You can be sure that we’ll look to provide your child with the best possible return. We also offer additional Children's Savings options to protect the finances of the children you care about.

How many ISAs can I have?

Now that you're familiar with the different types of ISAs, you might be wondering how many you can hold. Previously, you could open only one of each type of ISA per tax year. However, reforms for the 2024/25 tax year mean you can now open multiple ISAs, including numerous accounts of the same type, with different providers. That said, there are still limits to keep in mind: 

• You can only pay into one Lifetime ISA per tax year (up to £4,000).
• The total amount you contribute across all your ISAs cannot exceed the HMRC annual allowance, which remains at £20,000. 

You can spread your savings across different ISAs and providers as long as you keep an eye on the annual limits. 

Can I transfer an ISA?

If you’re unhappy with your current ISA or provider, you can transfer your ISA subscriptions between Cash, Stocks & Shares, and Innovative Finance ISAs without losing their tax-free status. Your new provider will manage the transfer process with your existing provider to ensure a smooth transition.

The beauty of transferring an ISA is that it doesn’t count towards your current annual allowance. This means you can transfer ISAs from previous tax years, in whole or in part, even if you’ve already used your £20,000 allowance for the current tax year.

Previously, transferring an ISA within the current tax year required moving the entire balance. However, as of April 6, 2024, you can make ‘partial’ transfers between ISA providers within the same tax year. Be wary that not all providers support partial transfers, so checking their terms and conditions before making a switch is essential. 

ISA Glossary

* Personal Savings Allowance (PSA):

Introduced in April 2016, the Personal Savings Allowance (PSA) now means most savers in the UK no longer have to pay tax on their savings income. Basic-rate taxpayers qualify for a £1,000 PSA so that they can receive up to £1,000 a year in savings income tax-free. Higher-rate taxpayers qualify for a £500 yearly allowance. ISAs are tax-free, so any interest from an ISA doesn’t count towards your PSA.

** Financial Services Compensation Scheme (FSCS):

The Financial Services Compensation Scheme (FSCS) is the UK’s statutory insurance and investors compensation scheme for customers of authorised financial services firms. The FSCS can pay compensation if a firm is unable, or likely to be unable, to pay claims made against it. The FSCS doesn’t cover investment performance.

*** Smoothing:

Smoothing refers to holding back some surplus profit in good years to top up returns in years where investment performance is not as positive.

Open or Transfer an Existing ISA with Sheffield Mutual

Are you interested in saving with Sheffield Mutual? Start your savings journey today by applying for your chosen ISA through our easy online application, by phone, or by post. Plus, make the most of your money with our Tax Exempt Savings Plan or Children’s Tax Exempt Savings Plan, which allows you to save tax-free on top of your ISA allowance – available exclusively through friendly societies like ours. 

If you have any questions, please don’t hesitate to get in touch. Our members are the people we care about the most. Simply fill out our contact form, and a dedicated team member will reach out to you. Alternatively, call us at 01226 741 000 or email [email protected], and our team will gladly assist you. 

Disclaimer: The rates quoted in this article are correct at the time of publication.

This blog provides generic information and the writer's opinions and should not be relied upon for investment decisions. Sheffield Mutual has not provided any financial advice. If you are unsure whether a savings or investment plan suits you, consider contacting a financial adviser for advice. If you do not have a financial adviser, you can get details of local financial advisers by visiting www.unbiased.co.uk or www.vouchedfor.co.uk. Advisers may charge for providing such advice and should confirm any costs beforehand.