Whether you’re saving for a car, a house deposit, or a rainy day, you may be wondering whether you’re better off opening a savings account or an ISA.
To help you make the right decision, we’ll explore how they differ. We’ll also consider the tax status of both, so that you can decide which one suits you best.
The differences between savings accounts and ISAs
On the surface, it might feel like there aren’t many differences between savings accounts and ISAs. However, once you get into the details, there are some key variations to be aware of:
Paying tax on your savings:
- The main difference between savings accounts and ISAs is that you’ll never have to pay tax on the interest you earn from an ISA. This applies regardless of the amount of interest you earn.
- You can also earn interest from a savings account without paying tax, but the amount is limited. The point at which you pay tax on your interest and the amount you need to pay relates to how much your total income is. Your total income includes pay from your job or pension, as well as interest from other savings accounts. Interest from ISAs isn’t included though.
- For full details about how savings interest works, head over to our article on the subject.
Deposit limits:
- ISAs allow you to deposit up to £20,000* each tax year. However, you can transfer funds from ISAs opened in previous tax years into a new account in addition to this.
- You can open more than one ISA each tax year and open ISAs with more than one provider. You just need to make sure that your total deposits into ISAs don’t go over £20,000 per tax year.
- Savings accounts generally have higher deposit limits than ISAs. In some cases, there won’t be a limit at all. This can be useful if you have a large lump sum that you need to deposit. For example, if you sell a property and decide to rent for a while before buying your next one.
- ISAs and savings accounts generally have a minimum deposit before you can open an account. This varies by provider. It can be as little as £1, but in some cases can be £1,000 or more.
- Depending on the type of account you go for, you may have a maximum amount that you can save each month as well. This is especially relevant if you plan to save a set amount each month.
Balance limits:
- Account balances often come with the same kind of restrictions that apply to deposits.
- Most ISAs and savings accounts will have a minimum amount that needs to stay in the account. Otherwise, it may become inactive or get closed.
- Some providers will also set a maximum amount that you can save in a particular account. In contrast, others will have no maximum limit.
Can I have a savings account and an ISA?
You certainly can. It’s entirely up to you how you spread your savings, and this could mean having a savings account and an ISA. You may even decide it’s worth having more than one of each.
If you have a significant sum of money saved, it’s worth considering the Financial Services Compensation Scheme. It provides security for up to £85,000* per eligible person, per UK authorised bank, building society or credit union. Bear in mind some providers trade under a range of different brands, so the compensation will only cover each banking group.
This compensation applies if the firm you’ve used goes out of business. If you have more than £85,000 savings in total with the same provider, anything over £85,000 won’t be covered. This applies even if you have multiple accounts and a mix of savings accounts and ISAs with a provider.
Which savings accounts are tax free?
If you have a savings account, you can earn a certain amount of interest each year without having to pay tax. However, this will vary in line with your total income. Handily, we’ve written a blog post about savings interest, so take a look and find out when you might need to pay tax.
And as we mentioned above, ISAs differ from savings accounts in one important way. Any interest you earn from an ISA is tax free, regardless of how much other income you have. ISAs come in a number of forms though, so we’ve written a blog to help you understand them all.
Is an ISA better than a savings account?
One way of looking at this is to consider how much you want to save in a specific tax year. If it’s more than £20,000, you won’t be able to save it all in an ISA. This means you’ll need to open a savings account as well as an ISA, or instead of an ISA.
If you’re planning to save £20,000 or less, ISAs tax free status can be an advantage.
However, bear in mind different accounts’ interest rates do vary. For example, you may find savings accounts that offer higher rates of interest than ISAs. Depending on how much you save per tax year, the total interest you earn from a savings account may mean you don’t pay tax anyway. In this case, a savings account with a higher interest rate could be a better option.
However, if you’re looking to save for the long term and don’t plan to save more than £20,000* per tax year, ISAs are the best way to ensure you won’t have to pay tax.
As always, consider your options carefully before you sign up for anything, and if in doubt speak to a financial advisor.
*figure correct at time of publication.
