ISA vs Savings Account: What’s Best for Your Savings?

If you’re committed to saving money for a rainy day, it’s sometimes difficult to know which options are best. For example, do you know the main differences between an ISA and a savings account?

Yes – an ISA is a type of savings account, but a few crucial differences may or may not appeal to you. In this guide, I’ll take you through all you need to know when considering an ISA vs savings account options.

As always, it’s a good idea to compare different banks and providers, too, as some brands may offer additional or different perks not listed here. Take your time and find a savings option that suits your needs and lifestyle!

A quick summary

If you’re running behind and don’t have time to check out my full guide below, here’s everything you need to take away between my rundown between ISA vs savings account options:

• ISAs allow you to save up to £20,000 per year and earn interest without tax.
• There are no savings limits on standard savings accounts, but you may have to pay tax if you exceed your personal allowance for the tax year.
• Savings accounts arrive in three different styles, with easy access being highly popular (so you can withdraw funds when you wish).
• There are four different types of ISA, including stocks and shares variations (where you can grow a portfolio).
• You can only save into one of each ISA type per tax year.
• Neither ISAs nor savings accounts carry huge asset risks, however, both are likely to drop your cash value if your interest rate falls below the level of inflation.

So – what is an ISA?

An ISA is an Individual Savings Account. ISAs are highly popular with British savers as they help you grow money efficiently, with a raft of tax savings to boot.

ISAs arrive with yearly allowances set by the government. At the time of writing, you’re allowed to save up to £20,000 in an ISA without paying tax on the interest you can earn.

There are some rules to remember when using an ISA. For example, you can only pay into one ISA of a specific type each tax year. There’s a host of additional information over in our ISA deposits guide if you’d like to learn more.

Are there different types of ISA?

Yes – in fact, there are four main types of ISA available to British savers:

• Cash ISAs
• Lifetime ISAs
• Innovative Finance (IF) ISAs
• Stocks and shares ISAs

All ISA types except the lifetime option allow you to pay in up to £20,000 a year. At present, the lifetime cap is £4,000. The main benefits to these different types are that you can generally grow money via interest without having to pay tax.

Many people prefer cash ISAs as they’re easy to access, and you can set fixed terms. However, stocks and shares allow savers to grow their money slightly differently – by diversifying in a portfolio.

Lifetime ISAs carry the additional bonus of a 25% boost from the government each year, all the way up to £4,000. Innovative Finance ISAs, meanwhile, are peer-to-peer lending options that offer competitive interest rates.

What are the benefits of running an ISA?

ISAs provide fantastic avenues for passive income through interest and dividends. If you have an influx of money you can save for the year ahead, you’ll get interest income just for saving in the right accounts.

What’s more, the ‘one account’ rule only applies to cash ISAs. If you’d like to split that £20,000 tax-free allowance in half between stocks and cash ISAs, you can. You just won’t be able to switch to other providers until the next tax year begins.

ISAs are considered extremely tax-efficient as you are not taxed on interest income, dividend income, or capital gains. While standard savings accounts will shield you from tax up to an extent, ISAs are by far the friendliest choice.

What are the drawbacks of running an ISA?

First of all, ISA interest rates are not always set in stone. In many cases, you will take out a cash ISA with a competitive rate of interest (e.g. 2%), only for this to drop to 0.1% the year after.

Stocks and shares ISAs, of course, carry their own individual risks. Placing any money in the markets carries a risk of you losing your investment if they simply don’t convert.

It’s also worth checking financial protection before choosing an ISA. Cash ISAs may be risky if you choose a variable rate. What’s more, IF ISAs aren’t exclusively protected by the FSCS.

Do also keep in mind that if you’d like to invest in a lifetime ISA, you won’t be able to withdraw (typically) unless you’re over 60, are a first-time homeowner, or have a terminal illness.

How much do I need to save monthly to hit £20,000 in a year?

In order to hit the £20k annual target, you would need to save £1,666 per month on an average. It’s not an easy target for many! If you find that to be too much of a stretch, you could try starting off with saving £1,000 a month. This would get you to a respectable £12,000 a month. You could always top it up with a year-end bonus by putting that fully in to your ISA account.

Or if that’s difficult, try to hit at least £500 a month. That will get you to £6,000 saved a year, which is still a very good number.

What is a savings account?

A standard savings account differs from an ISA in that it’s much less limited on what you can save and when. Depending on the precise type of savings account you choose, you can earn interest and access your money flexibly.

If you pay tax at the UK’s basic rate, you can make up to a total of £1,000 each tax year in interest before paying levies on top. If you’re in the higher rate bracket, the rate halves to £500 per year. This is based on what’s known as the government’s Personal Savings Allowance, or PSA.

If you’re over a certain age, you may benefit from our guide to the best savings accounts for people aged 60 and over. We detail what you can expect from specific savings accounts there – but for now, let’s quickly break down your options.

Are there different types of savings accounts?

Savings accounts in the UK generally split into three types or styles:

• Easy access
• Fixed term
• Regular

As the names suggest, easy access savings accounts allow you to withdraw funds (and you won’t have to pay a fee) – while fixed term accounts allow you to fix the rate of interest you get for a specific period.

Regular accounts, meanwhile, let you pay in up to a certain amount of money each month.

There are some other interesting options like premium bonds which are worth checking out too, though of course they’re not strictly a savings product.

What are the benefits of running a savings account?

The biggest benefit to running a savings account (not an ISA) is that you can start putting money away (and earn interest) without any kind of deposit threshold. However, you may still need to declare interest and pay tax on it at the end of a tax year.

There’s also very little risk involved with capital loss if you run a savings account. As with running an ISA, the only major risk to this end is if the UK’s rate of inflation stretches above your rate of interest return.

What are the drawbacks of running a savings account?

You may not be able to access or withdraw your funds for a specific amount of time depending on the savings account you sign up for. Easy access accounts, naturally, provide withdrawal flexibility – but others may not.

These accounts are also not as tax-efficient as ISAs, in that you’ll need to pay attention to your PSA for each year. In some cases, you may not be entitled to a PSA at all.

Therefore, for some savers, it may work out more cost-effective to pay into and earn interest via standard savings rather than an ISA. It all depends on your individual circumstances.

ISA vs savings accounts: what works best for you?

For most people, ISAs remain the most flexible and most economic savings options, purely because you can save high amounts without having to pay tax.

What’s more, the different types of ISA available also allow you to grow your money in different ways.

That said, savings accounts hold benefits on their own as they can be more flexible in terms of how much you can save per year. You just need to be careful with exceeding your personal allowance on the interest income.

Both options hold serious benefits for UK savers – just make sure you’re aware of what you might have to pay back to HM Revenue and Customs in the long run!

Want to Learn More About ISAs?

We’ve covered ISAs in great depth here on PFF and hopefully these articles help you navigate the complicated world of finance and taxes! Here are the list of articles to help you learn more:

1. Best Stocks and Shares ISA for Beginners
2. Junior Cash ISA vs Junior Stocks and Shares ISA
3. Lifetime ISA vs Pensions
4. Premium Bonds vs ISAs

If you’re ready to open up an ISA, some of our favourite providers include Plum, InvestEngine and Moneyfarm. There are many more providers, so if you want to dive in and learn more, you can explore the wide list of ISA providers that we have covered in depth here on the blog.

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