ISA vs savings account: which is best for you?

What's the difference between ISAs and savings accounts? It really comes down to tax. You don't pay tax on any potential returns from ISA contributions, while interest accrued on savings accounts can be taxed if it exceeds the personal savings allowance. 

Here, we compare different types of accounts to help you decide which might be best for you. If you'd like a personalised recommendation – or just the chance to ask a few questions about different products – you can always book a call with our friendly wealth services team. They're happy to help. Nutmeg provides restricted advice. This means our advice is limited to our own products and services.

In summary: the advantages and disadvantages of savings accounts and ISAs 

• ISA advantages: You do not pay tax on interest, dividends or investment returns on ISA contributions – which could potentially boost a nest egg significantly over a lifetime (returns are not guaranteed). 
• 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 or invest up to £4,000 annually in the Lifetime ISA and £9,000 in a Junior ISA.
• Savings account advantages: There is generally no limit to the amount you can contribute to 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.

ISAs in a nutshell

An Individual Savings Account (ISA) allows people to save or invest money and not pay any tax on interest, dividend income, capital gains, or returns. 

ISA accounts are either cash or stocks and shares.

• 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.  It's important to remember that investing carries the risk of loss, especially over shorter periods of time, which is why we recommend that you have a timeframe of least three to five years.  

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 withdrawal charge. You could get back less than you put in.  

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

• Innovative Finance ISA: For UK adults over 18 looking to invest in niche areas such as peer-to-peer lending. Please note that Innovative Finance ISAs are a high-risk investment. People should not invest in them unless they are prepared to lose money. We don't discuss Innovative Finance ISAs further in this blog.

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 current tax year. 

It's important to have a rainy day fund you can access easily, and savings accounts are often a good place for these. But for bigger sums, or additional savings, it's worth considering an ISA as well, because of their tax benefits. 

You can save or invest 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 or invest a maximum of £4,000 each year.  

The £20,000 ISA allowance applies across different ISAs, so if you put £4,000 into a Lifetime LISA, you will be left with £16,000 to go into a cash ISA and/or stocks and shares ISA in that tax year. The limit for a Junior ISA is £9,000. 

The basics: how do general savings accounts work? 

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

Personal Savings Allowance 

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

What are the best interest rates on savings accounts? 

Comparison sites such often 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, but you need to make sure you can afford not to access your money for that time. 

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 without paying a penalty for transferring.

Both general savings accounts and ISAs can be either: 

• Easy access – money can be withdrawn at request, although there may be daily limits on how much you can take out. 
• 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?

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

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

Our ISA calculator can show you how much you could make through investing in a stocks and shares ISA, although returns are never guaranteed. 

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 or investments held in any ISA or savings account with a UK-regulated bank or building society are likely to be protected from firm failure, up to a limit of £85,000 per person, by the Financial Services Compensation Scheme. You can still lose money when you invest, however, as the Financial Services Compensation Scheme does not cover poor investment performance, and the nature of investments means their value can go down as well as up.

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 withdrawal 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 child 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 work towards 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, although management fees and fund and market spread costs will be payable. Learn more here. 

*Winner of the following Boring Money Best Buy and Best For Awards 2023: JISA, ISA, Pension and LISA. Best for Customer Service and Best for Sustainable Investing in 2022. 

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 change. If you are unsure if an ISA is the right choice for you, please seek financial advice.

If you need to withdraw money from a LISA before you’re 60, and it’s not for the purchase of a first home, you’ll pay a 25% government withdrawal charge. If you choose to opt out of your workplace pension to pay into a Lifetime ISA, you may lose the benefits of the employer-matched contributions. Your current and future entitlement to means-tested benefits may also be affected. If you are unsure if a Lifetime ISA is right for you, please seek financial advice. 

To open a Nutmeg JISA, the child must be under the age of 16 and funds cannot be withdrawn until the child turns 18. Tax treatment depends on individual circumstances and may be subject to change. If you are unsure if a Junior ISA is the right choice for you and the child, please seek financial advice.

You can normally only access a pension from age 55 (57 from 2028). A pension may not be right for everyone and tax rules may change in the future. If you are unsure if a pension is right for you, please seek financial advice.