ISA vs. Savings Account

ISA vs. Savings Account

Financial planning is a must in the UK, and the earlier you can get your affairs in order the more secure your financial future will be. On this journey, one inevitable issue that many will come across is trying to figure out the differences between an ISA vs a savings account.

Figuring out which one is most beneficial for you could be crucial further down the line, with your choice having potential knock-on effects on your lifetime tax efficiency, any inheritance planning you’ll do, and your overall wealth preservation as you age.

If you can understand the key differences between an ISA and a savings account, you’ll be best placed to make an informed decision that will ultimately help secure your future finances.

Understanding ISAs and Savings Accounts

There are a number of similarities between an ISA and a savings account and some crucial differences that can vastly alter how much money you’ll ultimately end up with.

Savings accounts are relatively straightforward — it’s an account that you place money in so that you can earn interest on it over time. Savings accounts have no limits to the amount you can deposit, and no limits to how many you can open. One downside, however, is that you’re liable to pay tax on any interest accrued over £1,000 per year for a basic earner, or over £500 per year for high-tax earners.

Individual Savings Accounts, or ISAs, on the other hand, are tax-free savings accounts. You can save up to £20,000 per year across any accounts you hold, but you are limited to only opening one type of ISA per year. There are four distinct types you can open: a cash ISA, a stocks and shares ISA, an innovative finance ISA, or a lifetime ISA. The untaxed nature of these accounts makes them much more beneficial for long-term saving in comparison to a traditional savings account.

Benefits and Risks of ISAs and Savings Accounts

ISAs and savings accounts both offer several benefits when it comes to building your overall wealth.

ISAs offer the advantage of tax-free growth which, if investments are chosen wisely, can lead to life-changing wealth growth. Interest on these investments will also compound annually, meaning that if it’s left untouched for a long enough period the results will exponentially increase — providing that the investment plan around your ISA is sound. 

When it comes to inheritance planning, it’s important to note that your ISA can be inherited by your spouse, along with all of its tax benefits. However, other beneficiaries will be subject to inheritance tax. Inheritances of under £325,000 are tax-free, but anything over this will be taxed. This limit does rise, however, if you leave your home to your children or grandchildren — increasing to £500,000.

Savings accounts also offer a wide range of benefits. The funds in a savings account are very easily accessible, and can often be made liquid immediately. They’re also extremely simple to use and understand, making them a great entry-level method to begin planning for your financial future. While they don’t offer any tax benefits, unlike ISAs, they can still be inherited tax-free subject to the same limitations placed on your overall estate outlined above.

There are risks associated with both types of accounts, but they can vary quite a bit. Savings accounts have little to no risk, with the only real risk being that your interest rate gets outpaced by inflation. When this happens, your savings could potentially begin to lose some of their value. The same risk applies to cash ISAs.

For the other types of ISAs, it should be noted that all investments have a chance to reduce in value. You need to be aware of your risk tolerance when opening one of these, as while the reward can be great, there is an inherently bigger risk of loss.

Making Informed Decisions with Savings Accounts

Before deciding on what type of account might suit you best, it’s important to analyse some factors that might help you to choose. Consider your current financial goals, what your risk tolerance looks like, and if you have specific needs around inheritance planning. If you can reach definitive answers to all these questions, you’ll be in a much more secure place to begin investing in your future. 

You should also reach out to a qualified financial adviser for advice, as they’ll be best placed to inform you of what you can expect with each account, and can offer professional insight into what might suit your needs best.

There are several misconceptions about ISAs and savings accounts, chief among them being that ISAs are not subject to inheritance tax. As discussed, this only applies if it’s being inherited by your spouse or civil partner. 

There’s also the idea that you need to be contributing a large amount of money into your accounts each month. This is simply untrue. While large deposits will certainly help, you can start with relatively small amounts that are in line with your current financial situation, and then look to increase them over time.

Conclusion

ISAs and savings accounts both offer significant value to anyone looking to take control of their finances and actively plan for their future. ISAs tend to benefit larger sums and a more long-term outlook, while savings accounts offer more day-to-day flexibility and suitability towards smaller sums.

The most important thing you can do is begin planning now, by figuring out your financial goals and trying to find an account that suits your needs now and into the future. Being proactive will enable you to preserve or even grow your wealth as you age.

It’s highly recommended that you consult a qualified financial adviser, and we here at The Openwork Partnership specialise in providing personalised guidance on inheritance tax planning and investment strategies. We offer tailored advice in our consultations and ultimately want to assist you in making the most well-informed financial decision you can to safeguard your future. 

An ISA is a medium to long-term investment, which aims to increase the value of the money you invest for growth or income or both. The value of your investments and any income from them can fall as well as rise. You may not get back the amount you invested.

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.