ISA stands for Individual savings Account and they were set up by the government as a way to save money tax free. They used to be attractive to savers who paid tax as they would give them a tax break on the interest that they got. This meant that tax payers would use it instead of a conventional savings account so that they could get a better return on their savings. However, they are not so popular now for a number of reasons.
The government have now changed the rules on tax on savings from interest. If you are in the basic rate tax band you can receive up to £1,000 in savings interest before being taxed on it. If you are in the higher rate band you will not be taxed on the first £500 and if you are on the additional rate tax band then you will have to pay tax on it. This applies to savings in banks and building societies, credit unions, unit trusts, investment trusts, open ended investments, peer to peer lending, government and company bonds, life annuity payments and some life insurance contracts. This means that for many people the attractiveness of an ISA has been lost because there is no longer a benefit of not having to pay tax on the interest received as it tends not to be taxed for many people anyway. Obviously high earners or those who receive a large amount of interest may still need to pay tax and therefore may still benefit from an ISA.
It is worth comparing interest rates as well. If you look at how high the interest rate is on an ISA compared with a savings account, then you will be able to see whether it is worth getting an ISA or not. You will probably find that there are many different rates with different companies. You may want to use a comparison website to help you find what is available more quickly. There are many out there and you may also find websites which will let you know who has the best rates which could be useful. It is worth remembering that although comparison websites can be useful in giving you an idea of what rates are available, they only compare a selection of sites. Some places never appear on them and only deal with customers directly and some comparison websites only list companies that pay them commission, so you need to do a bit of work yourself as well, if you want to make sure that you get the best possible rate.
It is worth noting that there are several types of ISA and the above only applies to cash ISAs. There are also other types of ISAs and these work very differently. An innovative finance ISA covers things like peer to peer lending, crowdfunding, lending to businesses and property. It basically covers any interest that you get from lending money to people. This is a risky way to invest your money, but if you do make a good return, then wrapping it in this sort of ISA will reduce or eliminate interest.
A lifetime ISA is a fairly new way to save and allows you to save £4,000 a year with a 25% bonus paid by the state and there is interest on top. There are limitations though with the bonus only being paid until you are 50.
A stocks and shares ISA allows you to invest money in stocks, shares or bonds and not pay tax on some or all of the return that you get. You do not have to pay capital gains tax on the profits made from share price increases, no tax on interest earned by bonds and no tax on dividend interest. The capital gains tax is payable at income tax allowance levels and dividends are taxed after £5,000 of income and if you are a higher tax rate payer you would pay 25% and an additional rate tax pater 30.56%. There are often fees associated with these though and so it is worth looking hard into them before you sign up for one.
It is worth noting that the tax free benefits of ISAs really only apply if you have already used up your tax free allowance for savings interest and/or if you pay higher rate tax. Otherwise you may find that you can get a better rate on a savings account without specifically looking for an ISA. However, if you have investments, then it is worth seeing whether there is an ISA which will work for you and help you to reduce your tax burden on your returns.