Should I Get an ISA or a Savings Account?
Unsure where to save? Explore the differences between ISAs and savings accounts. Learn which option aligns best with your financial goals and tax situation.
Choosing between an Individual Savings Account (ISA) and a traditional savings account involves understanding their distinct features and tax implications. This article explores the characteristics of each to help you make an informed choice for your financial goals.
Defining Savings Accounts
A savings account provides a secure place to deposit funds while earning interest, serving as a tool for short-term and emergency savings. Offered by banks and building societies, these accounts allow individuals to accumulate money over time. Interest rates can be variable, fluctuating with market conditions, or fixed for a set period. Funds are typically accessible, though ease of access depends on the account type; easy access accounts allow immediate withdrawals, while notice accounts may require advance notice for a potentially higher rate. Interest earned on standard savings accounts is considered taxable income.
Defining Individual Savings Accounts (ISAs)
An Individual Savings Account (ISA) is a UK-specific savings and investment account designed for tax-free earnings on interest, income, or capital gains. This tax-efficient structure is a primary distinction from standard savings accounts. Each tax year, individuals receive an annual ISA allowance, which is £20,000 for the 2025/2026 tax year, allocable across various ISA types.
Types of ISAs
Cash ISA: Functions like a traditional savings account, offering tax-free interest on cash deposits.
Stocks and Shares ISA: Allows investment in assets like stocks and funds, with profits and income free from UK income tax and Capital Gains Tax.
Lifetime ISA (LISA): Helps those aged 18 to 39 save for a first home or retirement, offering a 25% government bonus on contributions up to £4,000 annually until age 50.
Innovative Finance ISA (IFISA): Enables tax-free interest earnings from peer-to-peer lending.
Comparing Key Features
The primary distinction between ISAs and traditional savings accounts is their tax treatment. Interest earned within an ISA is entirely free from UK income tax and Capital Gains Tax. Conversely, interest from a standard savings account is generally taxable. However, the Personal Savings Allowance (PSA) provides a tax-free threshold for savings interest outside an ISA: typically £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers. Additional-rate taxpayers do not benefit from a PSA.
Contribution limits also differ. Traditional savings accounts usually have no annual deposit limit. ISAs, however, are subject to an annual allowance of £20,000 for the 2025/2026 tax year, across all ISA types.
Fund accessibility varies by account terms. Many savings accounts offer easy access, while others may be notice accounts. Cash ISAs can also offer instant access or fixed-term options with restricted withdrawals. Some ISA types, like Lifetime ISAs, have specific conditions for tax-free withdrawals, such as for a first home purchase or after age 60, with penalties for early withdrawals.
Regarding risk, cash savings accounts and Cash ISAs generally have a lower risk profile, with deposits protected by the Financial Services Compensation Scheme (FSCS) up to £85,000 per eligible person, per institution. Stocks and Shares ISAs and Innovative Finance ISAs involve investment risk, meaning the value of investments can fluctuate, and there is a risk of borrower default in peer-to-peer lending.
Factors for Your Decision
When deciding between an ISA and a savings account, consider your financial goals. For short-term needs like an emergency fund, an easy-access savings account or Cash ISA offers liquidity. For long-term objectives such as retirement or a first home, various ISA types offer tax advantages and growth potential.
Your current tax position is also important. If your annual savings interest earnings might exceed your Personal Savings Allowance, an ISA is attractive as all interest within it remains tax-free. If your interest income is well within your PSA, a standard savings account may suffice without tax liability.
Evaluate your risk tolerance. If capital preservation is a priority, cash-based options like traditional savings accounts or Cash ISAs are lower risk. If you are comfortable with potential fluctuations for higher long-term returns, a Stocks and Shares ISA or Innovative Finance ISA may align with your risk appetite.
Assess your need for fund access. For frequent or immediate access, an easy-access savings account or flexible Cash ISA is appropriate. For long-term goals where funds can be committed, fixed-term savings accounts or ISAs with withdrawal restrictions might offer better interest rates.