ISAs vs savings accounts: which is better for you?

What is an ISA?

An ISA is a type of savings account. 

The main attraction for many people is that each tax year, you can benefit from a tax-free allowance, which is currently £20,000 in combined deposits (for most types of ISA).

Provided you stay within this limit, you won’t pay tax on the interest you earn or any investment growth within your ISA ‘wrapper’. 

There are several types of ISA, including: 

• Cash ISAs: This is similar to an ordinary savings account, but your interest is protected from tax. 
• Stocks and shares ISAs: These protect a range of investment incomes from tax. 

Depending on which provider you choose, you’ll find many options, including Junior ISAs and Lifetime ISAs, which have lower annual limits.

Exactly which you go for will depend on your financial aims. 

Apart from Lifetime ISAs, you can have multiple ISAs of the same type and choose to put all your allowance into one ISA or split it between several.

Additionally, from April 2024, savers are now allowed to open multiple ISAs of the same type within a tax year without losing their tax-free ISA allowance.

You can't carry over your allowance into future years, so if you only invest £10,000 in one year, that doesn’t allow you to invest £30,000 in the following year. It’s a £20,000 limit each year.

An ISA can be tax efficient if you’re saving up to £20,000, and it can be passed on to your spouse or civil partner if you die without tax penalties.

What is a savings account?

A savings account allows you to put away money you don’t need to spend right now to earn interest.

Some accounts will let you withdraw your money immediately, while others have restrictions on withdrawals. 

Here are the three main types you’ll encounter: 

• Easy access accounts: You can withdraw your money at any time without paying a penalty. Interest rates aren’t usually fixed, so they can change.  
• Fixed-term accounts: This type of account lets you put money away for a set period of time and pays a fixed rate of interest. There may be restrictions on how you access your money. 
• Limited access savings accounts: These accounts usually offer a higher interest rate, however, there may be restrictions on how you access your money such as limited yearly withdrawals.

One advantage of savings accounts is there’s no annual limit on how much you put in. 

While you don’t get the high tax-free threshold of an ISA, basic-rate taxpayers can use their personal savings allowance (PSA) to earn up to £1,000 a year in interest without paying tax.

Higher rate taxpayers can earn up to £500 each year, while additional rate taxpayers don’t get an allowance.  

Savings accounts offer flexibility when it comes to accessing your money, which can be useful in an emergency.  

ISAs vs savings accounts: what are the risks? 

There’s some level of risk with stocks and shares ISAs, including inflation, fluctuations in the market and potential loss of your capital, while rates on cash ISAs might not beat inflation. 

By contrast, a savings account will be exposed to inflationary or insolvency issues if your provider goes out of business.

Learn more: SIPP vs ISA: which one should you choose?

Can you have an ISA and a savings account? 

Yes, you can. If you have the funds, you could put money into an easy-access savings account while gaining tax-free benefits from an ISA. 

Whether an ISA or a savings account is the best option depends on your individual needs and lifestyle.

So, consider how much you want to save, if instant access is a priority and whether an ISA can shelter you from unnecessary tax.  

If you’re unsure, it’s worth talking to a financial adviser.

Get expert financial advice

Both ISAs and savings accounts offer valuable ways to manage and grow your money, each with distinct benefits and limitations.

ISAs provide tax-free advantages and are suitable for larger savings, while savings accounts offer flexibility and accessibility.

Understanding these differences can help you make an informed decision based on your financial goals and needs.

Whether you choose an ISA, a savings account, or a combination of both, aligning your choice with your personal financial strategy is key to achieving your savings objectives.

Let Unbiased match you with a financial adviser for expert financial advice to help you navigate the benefits and options of ISAs and savings accounts so that you can make the most of your financial planning.