You might hear people mention “ISA” and savings, especially during the new year leading up to April. But what is an ISA and how is it relevant to me as a doctor?
What is an ISA and why is it useful?
An ISA is an “individual savings account”. It allows you to save and invest money tax-free.
Various taxes are often applicable to savings. For example, you may have to pay tax on savings interest if your salary or interest payments cross a certain threshold. If your savings are invested in stocks and shares, you might have to pay capital gains taxes or dividend taxes.
Savings within an ISA are free of these taxes. It’s often called a “tax-wrapper”, meaning that any money placed into these accounts is wrapped away and shielded from the applicable taxes.
While it might not seem like a significant benefit at the start of your career, it really does make a huge difference once you’ve saved more and compound interest starts to have an effect over multiple years!
What are the different ISA types?
There are four main types of personal ISA:
- Cash ISA
- Stocks and Shares ISA
- Lifetime ISA
- Innovative finance ISA
You may also hear about or have a Help to Buy ISA, however, this has now been replaced by the Lifetime ISA and is no longer open to new savers.
There is also a Junior ISA, which can be opened on the behalf of a dependent child, but we’ll cover this later on.
How do I use an ISA?
To be eligible for an ISA, you must be:
- Be 16 or older (18+ for a Stocks and Shares ISA)
- Be resident in the UK
- Have a National Insurance number
Everyone who meets the above criteria then has an ISA allowance of £20,000 in each tax year (which runs from 6th April to 5th April the following year.
Each tax year, you have a brand new £20,000 allowance. Unfortunately, the allowance does not roll over into subsequent years – so if you do not use all your allowance, it will be gone.
This ISA allowance can be split among any combination of the four types of ISA, but you can only pay into one of each in each tax year.
Note that some ISAs are flexible – you can withdraw the money and pay it back in before the end of the tax year. Others are fixed and have restrictions on withdrawing the money.
You can add to your ISA accounts every year, and the funds continue to accumulate with interest or returns on your investment. They will continue to be tax-free as long as you keep the money within the ISA.
Which ISAs should I use?
These are the most straightforward type of ISA. They are similar to most bank savings accounts and pay interest on savings held. Currently, interest rates are at a historic low, and most providers give a rate between 0% and 1.5%.
When comparing providers, take note of any rules on withdrawals (e.g. how quickly you can access the funds if you need them), interest rates and any associated fees.
Stocks and Shares ISAs
Stocks and Shares ISAs allow you to invest the money held within an ISA, in shares and investment funds. You can read more about investments in our dedicated article on the topic.
Stocks and Shares ISAs offer the highest return on your savings, however also come with the highest risk of loss – and at time of withdrawal, you could potentially have less money than you started with.
Bearing this in mind, it is well established that this risk is very small (but not negligible) when money is invested for long timeframes.
You can use comparison tools like MoneySavingExpert’s to help choose your ISA provider. Once you’ve done this, you can choose which shares or funds you’d like to invest in.
Note that your provider may charge fees within a Stocks and Shares ISA – including a flat fee for using their platform, a fee for purchasing and selling funds, an annual management fee determined by the fund itself, and a fee if you want to transfer your money out of the ISA.
Vanguard is notable among Stocks and Shares ISA providers for having extremely low management and platform fees, a wide range of passive and active funds to choose from, and no transfer-out fees.
Trading212 also allows you to use a Stocks and Shares ISA to purchase individual shares with reasonable fees, if that would be your preferred option (referral link).
Lifetime ISA (formerly Help to Buy ISA)
A Lifetime ISA (LISA) is a specific, restrictive type of ISA.
It is designed for use in purchasing your first home, or for retirement. Its use is therefore restricted to these circumstances.
You can pay in up to £4,000 per tax year into a LISA (not the full £20,000 of your annual ISA allowance – you can then use the other £16,000 of your annual ISA allowance to pay into other types of ISA).
The government will add a 25% bonus to your LISA contributions (up to £1,000 per year).
You can open a LISA if you’re between 18 and 40 years old, and pay into a LISA between the ages of 18 and 50. You cannot open a LISA if you are aged 40 or older.
This money can then be withdrawn without incurring a penalty if either:
- It’s used to purchase your first home (maximum £450,000 in value, and at least 12 months after you open the LISA), or
- You’re over the age of 60, or
- You’re terminally ill
In other circumstances, any withdrawal will incur a 25% penalty of the amount withdrawn (effectively removing the initial government bonus, then about 6% extra).
A LISA can be held in cash, or in stocks and shares, depending on your provider.
Innovative Finance ISA (IFISA)
These ISAs allow you to use your savings to gain interest via peer-to-peer lending. Peer-to-peer lending aims to match investors with borrowers (who can be individuals, businesses or property developers).
They are extremely high risk and should be used with caution, as any losses have no claim to be recovered.