The deadline to invest in Individual Savings Accounts (ISAs) for the 2024/2025 tax year is almost upon us.
You only have until midnight on Saturday 5th April 2025 to use your allowance. This marks the end of the tax year, after which any unused portion of your £20,000 ISA allowance cannot be carried over. A new allowance becomes available on 6th April.
ISAs offer several different ways to save and invest tax-efficiently. There are five main types:
- Cash ISAs work like regular savings accounts but with tax-free interest;
- Stocks & Shares ISAs allow investment in shares, bonds, funds and other securities;
- Lifetime ISAs, or LISAs, are aimed at individuals aged 18–39 who are looking to save for specific financial goals, such as buying their first home or saving for retirement
- Innovative Finance ISAs, or IFISAs, involve peer-to-peer lending, where you lend money to individuals or businesses; and
- Junior ISAs, or JISAs, are for children under 18, although they are managed on their behalf by parents or guardians.
There is currently a personal ISA allowance of £20,000, which is the maximum amount you can put in without paying tax on interest, dividends or capital gains.
You can split your £20,000 across different types of ISAs, or put it all into one. However, you can only save up to £4,000 per year in a LISA, or up to £9,000 in a JISA. And you can only open and pay into one of each type per tax year.
You don’t have to use the full £20,000, but unused allowance doesn’t roll over to the next tax year.
Are ISAs or pensions best?
An ISA is an example of what we call a tax wrapper, a financial structure that shields investments or savings from certain taxes. But it’s not the only one. The most widely used tax wrapper of all is thepension, of which there are two main types, personal pensions and workplace pensions.
So, should you use ISAs, pensions or both? Well, it principally depends on three things, your individual financial goals, your tax situation and when you need access to the money.
The biggest advantages of a pension, especially for higher earners, is that investors receive income tax relief at their marginal rate (20%, 40% or 45%). So, a £100 contribution only costs £80 (basic rate), £60 (higher rate), or £55 (additional rate). When you access your pension (from age 55, rising to 57 in 2028), 25% of it is tax-free; the rest is taxable as income.
Also, almost all workplace pensions now come with employer contributions, which is essentially free money.
The main disadvantage with pensions is that you can’t access your money before age 55 (or 57 from 2028).
As for ISAs, the main advantage is their flexibility. You can withdraw money at any time without penalty (except LISAs before age 60 unless buying a first home). Unlike pensions, however, you don’t receive an upfront tax break when putting money in.
Generally speaking, pensions are the better option for retirement savings, because of the tax relief available, especially to higher-rate taxpayers, and employer contributions. If it’s flexibility you’re after, ISAs are the winners because you can withdraw money tax-free at any time.
Is there a case for both?
But it’s not a case ofeither investing pensionsor in ISAs: you can, of course, invest in both.
As a firm, we advise our clients to prioritise pensions first, for the reasons already stated. The abolition of the Lifetime Allowance (LTA), the cap on tax-relieved pension savings, introduced by the last Conservative government, added an extra incentive to focus on pensions. Despite its initial opposition to the change, Labour later dropped plans to reverse it, and, as of now, the Labour Government has not announced any plans to reinstate the LTA.
We would certainly encourage anyone in a workplace pension whose employers are willing to match the member’s contributions to pay in the maximum amount allowed.
If, however, you need flexibility or you’re saving for something specific, a wedding or big foreign holiday, for example, it makes sense to use ISAs as well as pensions.
There may also be a tax advantage in having a tax-free ISA buffer, in addition to your pension, if you’re approaching retirement. Having this buffer can help you manage your income tax liability by reducing how much you need to withdraw from your pension each year. The tax savings could be considerable.
But be warned: if you’re thinking about a tax-free ISA buffer, the calculations can be complex, and it’s very important to seek professional financial advice to prevent costly mistakes. This is especially true if you have a large pension pot or multiple sources of income.
Which is the right ISA for you?
So, if you’ve decided to invest in an ISA, which one is right for you?
For younger adults looking to buy their first home, a Lifetime ISA can be a good option, particularly as the government adds a 25% bonus to your contributions.
If you want to build long-term savings for your children’s future education, say, or a deposit on their first home, Junior ISAs do make sense, especially as the £9,000 annual allowance is separate from your personal £20,000 ISA allowance. Because these are long-term savings, we would definitely recommend a Stock & Shares JISA over a Cash JISA because, if stock markets fall sharply, there is still plenty of time for them to recover. If your children have any special needs, you should seek advice before you invest in JISAs as they could lose your child valuable means-tested benefits.
Innovative Finance ISAs may appeal to those who are willing to take higher risk in return for potentially higher returns. However, for most investors looking for better returns than cash, a Stocks & Share ISAs is usually the way to go.
Is there a case for using a Cash ISA? Well, it’s crucial that everyone has a cash buffer to ensure financial security in the event that they lose their job or suddenly face unforeseen costs.
As a rule of thumb, we recommend that people have around six months’ worth of essential expenses in cash as an emergency fund. If you don’t already have that much in savings, a Cash ISA may be an option worth considering. But bear in mind that you will almost certainly find much higher rates of interest on cash accounts outside the ISA wrapper.
If, on the other hand, youdo have that much cash saved already, and there are no short-term goals you need to save for, a Stock & Shares ISA is almost certainly the better option because of the potential for higher growth that they provide. The value of your investment will inevitably fall from time to time, but if you’re investing for at least five years, the chances are that your eventual returns will be higher than if you stick to cash.
One final word of warning: we all have different needs and circumstances. This article is not personal advice based on your particular situation.
CAN WE HELP?
If you are unsure about what the best options are for you, why not get in touch with us? We would be delighted to offer you a free consultation.
