After setting the goal of saving money, one of the key decisions to make is how you will save. Two options are Individual Savings Accounts (ISAs) or savings accounts.
While both will help your money grow, picking the right one (or combination) for your circumstances will help ensure it’s growing as fast as possible.
What is an ISA?
ISAs are a tax-efficient way to save money. The government sets a limit for how much can be saved each financial year and doesn't charge tax on the interest/income earned. In the 2020/2021 tax year this limit is £20,000. There are several types of ISAs including:
- Cash ISAs – these are like ordinary savings accounts, except interest on your savings is protected from tax
- Stocks and shares ISAs – these protect various types of investment income from tax
Some ISAs have certain conditions and bonuses that can help speed up your saving.
What is a savings account?
You can use a savings account to put away money you don't need immediately in order to earn interest. Depending on your circumstances, you may be charged tax on the interest earned. Some accounts may also have restrictions on making withdrawals.
- Easy access accounts – you can withdraw your money whenever you like without paying a penalty. The interest on these accounts is usually not fixed, so banks may alter the interest rate.
- Fixed term accounts – you can put your money away for a set period of time during which it will earn a fixed rate of interest.
- Regular savings accounts – you can contribute money into these each month up to a certain limit. They usually offer a slightly higher interest rate than ordinary savings accounts. There may be restrictions on how you access the money.
What ISAs can offer
If you’re saving an amount up to £20,000 an ISA offers you a tax-efficient way to save your money.
The value of an ISA can also be passed on to your spouse or civil partner tax-efficiently by way of an allowance if you pass away. This isn't the case with an ordinary savings account. For this to take place, the government requires you:
- to be living together at the time of death
- to not separated by court order deed of separation
- to not be in a circumstance where the marriage or civil partnership has broken down1
What savings accounts can offer
There's no annual limit on how much you can put into savings accounts.
With your Personal Savings Allowance (PSA) you can:
- earn up to £1,000 a year in interest on savings tax-free if you're a basic rate taxpayer
- earn up to £500 a year tax-free if you're a higher rate tax payer
However, this depends on your individual circumstances and may be subject to change in future. Additional rate taxpayers do not qualify for a PSA.
Some savings accounts can also offer more flexibility in accessing your money. This can be helpful if you’re not comfortable locking away your money for a set period.