What is an Individual Savings Account?

An ISA or Individual Savings Account is a government scheme allowing individuals to hold cash, shares and unit trusts free of tax on dividends, interest and capital gains.

The government launched this type of savings account as an effort to encourage people to save for the future. It is effectively a tax-efficient wrapper in which you can hold either stock market-based investments or a traditional savings account.

Any interest earned on savings or bonds and any capital gains made on investments held within an ISA are tax free. In other words, both HMRC (the tax man) and the Student Loan Company don't chase you for the money you make on this type of account.

Individual Savings Accounts come with a limit on how much you can invest each year. In 2017/2018, this is set to £20,000. If you don't put any money away at all, you'll lose your tax-free wrapper for that year. The limit resets each April, when you will get a new allowance for the next tax year.

Any investments or savings which stay within the tax-free ISA wrapper will continue to earn interest until you withdraw the money.

ISA flavours

ISAs come in two different flavours:

Easy-access: with this type, you can withdraw your cash if you need it. This is particularly handy if you are a student and want to start putting some money aside. However you may not be able to put it back, if you have exceeded the ISA allowance for that year. In this case, the interest rates are variable and can include a tempting, but temporary, bonus.

Fixed-rate: with this other flavour, your interest rate is fully guaranteed and is usually higher. The downside is your money is locked away for a year or more. You should open this account only if you are certain, you don't need the money. This is the case because there are penalties for early withdrawals.

You can have more than one Individual Savings A, but you can only pay into one each tax year. This means if you have two ISA accounts, but want to invest only a portion of your allowance in the second, this could be problematic since you won't be able to add any money to the first in the same tax year.

This rule only applies for certain providers. For example, if you have multiple ISAs with Nationwide, you can still split your allowance in different ISAs. These are in jargon called "split-ISA" providers, because they allow to use the allowance into multiple accounts.

Our guide provides an extensive breakdown of the different types.