What is a cash Isa account? Do I need one? - Times Money Mentor (2024)

A cash Isa lets you earn tax-free interest on your savings and you can put up to £20,000 in one each tax year.

Since the Bank of England started hiking interest rates in December 2021, these savings products have become more popular. This is because many savers who were not previously paying tax on their interest are now be eligible to do so. If you think you might benefit from the tax perks a cash Isa offers, we break down how they work and whether they might be right for you.

In this article, we explain:

  • What a cash Isa is and how does it work?
  • What types of cash Isa are available?
  • Differences between a cash Isa and stocks and shares Isa
  • What are the disadvantages of a cash Isa?

Read more: Best cash Isas in 2024

What is a cash Isa?

A cash Isa is similar to an ordinary savings account except there is no income tax to pay on any interest you earn.

There is also a limit set by the government of how much you can save into your Isa each tax year while still enjoying the tax-free benefits.

During the 2024/25 tax year, you can stash up to £20,000 in a cash Isa or spread that allowance across any combination of cash, stocks and shares, lifetime or innovative finance Isa.

Read more: Will I pay tax on my savings this year?

You cannot pay into more than one type of Isa in a tax year, but this will change from the next tax year in April.

There are different types of cash Isa depending on when you want to access your money.

Unless you have a flexible Isa (see below), if you take money out of your cash Isa you can’t reset the annual limit. For example, if you saved £20,000 and withdrew £2,000 in one tax year, you need to wait for the next tax year to top up that £2,000.

With a flexible Isa, you can withdraw and put money back in at a later date in the tax year without affecting your allowance.

Check out our independently rated best cash Isas.

What’s the difference between a savings account and a cash Isa?

While a general savings account and a cash Isa are similar, there are a few key differences:

  • You don’t pay tax on any interest earned on your money in a cash Isa – unlike a savings account
  • There is a limit as to how much money you can save tax-free in a cash Isa each tax year – currently £20,000 (2024/25)
  • You can only subscribe to one cash Isa in any given tax year; you can have lots of savings accounts

Find out more about how Olivia uses a mix of savings accounts and Isas to fund her plan to buy a first home.

What are the different types of cash Isa?

You can choose from different types of cash Isas depending on what you want to use them for:

  • Variable rate or easy-access: The most popular option, offering instant access to your money without paying a penalty
    • pay at a variable interest rates, which can go up or down
  • Fixed-rate: Offer a set rate of interest over a certain length of time
    • you must tie your money up for, say, one, three or five years or you could face a penalty
    • usually pay at a higher rate than the easy access

Fixed-rate Isas generally offer more attractive returns – but it’s not necessarily the case that the longer the lock-in period, the better the deal.

You can also get cash Isas for kids called Junior Isas or to help you buy your first home, known as Lifetime Isas

  • Junior Isas: Can only be opened by a parent or legal guardian of the child but anyone can contribute, including grandparents, up to the maximum allowance of £9,000 in the 2023/24 tax year
  • Lifetime Isa: Allows first time buyers aged 18-39 to save up to £4,000 in the 2023/24 tax year, with the government topping up by 25% whatever you can contribute.It can only be used for the deposit for your first home or for retirement.

Read more about the different types of Isas you can choose from in our Isa Guide: Which Isa should I get?

How do I open a cash Isa?

Opening a cash Isa is pretty straightforward and won’t cost you a penny.

  • Set up at banks or building societies or other financial institutions
  • Online or in branch
  • Must be 16 or over
  • Must be a UK resident

You can only open and pay into one cash Isa in any given tax year but that doesn’t include transfers from old Isas into new ones.

Remember that returns on cash Isas vary so shop around first. If you opt for a fixed-rate Isa, make sure that you know when the term is up and you move your money to get the best possible rate.

To make sure you are getting the top rate of interest from your savings, check out our article on the best savings accounts in 2024.

Which ISA is right for me?

ISAs work best when you pick the right one for your savings goal. Take this short survey to find out which ISA might be right for you.

  • It only takes a couple of minutes
  • No personal details required

What is a cash Isa account? Do I need one? - Times Money Mentor (1)

What’s the difference between a cash Isa and stocks & shares Isa?

A stocks and shares Isa has all the tax benefits that you’d expect from a cash Isa but the money you put into the account is invested in the stock market, so the value of your pot can go down as well as up.

With a stocks and shares Isa you take on more risk with your money in the hope of greater reward. Which you choose depends on your:

  • Financial goals
  • Time frame
  • Appetite for risk

Investing in the markets should really be for the long term, five years or more, to help give you time to ride out any downturns and profit from a share-price recovery.

Remember: the value of your investments can go down as well as up and you may not get back all the money you put in. All investments carry a varying degree of risk and it’s important you understand the nature of these risks.

If you think you will need your money in the next five years – to buy a house or pay for a wedding, for example – then a cash Isa would likely be a better bet.

Find out how Nicola is using her stocks and shares Isa to help her retire early. If you are looking for a ready-made stocks and shares Isa, check out our independent ratings here.

What is a cash Isa account? Do I need one? - Times Money Mentor (2)

Can you lose your money in a cash Isa?

Unlike investing, the money you save into a cash Isa can’t go down, but if the interest rate being paid to you is less than the rate of inflation, your pot will be losing value.

So while you won’t technically lose money, you will be able to buy less with those savings as time goes on.

Cash Isas have the added protection of the Financial Services Compensation Scheme (FSCS) which will look after up to £85,000 of your money should the bank or building society go bust.

Make sure your Isa provider is authorised and regulated by the Prudential Regulatory Authority to get protection from the FSCS. We have more on this in our article: Can you lose your money in an Isa?

What are the disadvantages of a cash Isa?

Cash Isas became less popular in recent years for a number of reasons:

  • Savings accounts tend to pay a higher rate of interest
  • High inflation at the moment means your money is losing value in cash savings
  • Most people can earn up to £1,000 in interest on their savings tax-free due to the personal savings allowance
  • You are limited to adding £20,000 in the 2024/25 tax year

However, rising interest rates have led to cash Isas surging in popularity due to the personal savings allowance.

What is the personal savings allowance?

The personal savings allowance (PSA) was introduced in 2016 which changed the way that interest earned on savings was taxed:

  • Basic-rate taxpayers can receive up to £1,000 in a tax year in savings income tax-free.
  • Higher-rate taxpayers, have a PSA of £500 a year
  • Additional rate taxpayers receive no PSA and therefore need to pay tax on any income they receive on savings outside a cash or stocks & shares Isa

With rates rising dramatically in recent months, more savers with normal savings accounts have found themselves paying tax on their interest. This is because as their interest earnings have increased, some savers have breached their personal savings allowances.

For example, the best rate on a one-year fixed savings account a year ago was 1.10%. A basic-rate taxpayer would need to save at least £91,000 to earn above the personal savings allowance threshold of £1,000.

The best one-year fixed saving rate in May 2023 is 5%, which means the same saver would now earn more interest than the £1,000 personal savings allowance with a balance of around £20,500.

What happens if I break the rules?

There are a number of rules to follow with Isas, including:

  • Who can open one
  • The amount you can pay in each tax year
  • How many you can pay into in each tax year
  • When you can withdraw your money

If you break the rules – which you can do unwittingly, especially if you have more than one Isa with different providers – HMRC will find out if it checks your record at the end of the tax year.

Note: You can’t get away with withdrawing that money if you realise you have gone over your limit before the end of the tax year.

First-time offenders are likely just to receive a warning letter. However HMRC can tell your Isa provider to remove the extra money and subject any income tax or growth related to it to tax.

HMRC has an Isa helpline you can call if you think you may be in this position: 0300 200 3312.

What happens to my cash Isa when I die?

A surviving spouse or civil partner that you were living with at the time of your death can inherit your Isa, without the funds affecting their own subscription allowance for that tax year.

These transfers are known as the additional permitted subscription allowance (APS). For example:

  • you had £75,000 in Isa savings
  • your partner has a £20,000 allowance
  • the total Isa allowance for your surviving partner’s = £95,000

NOTE: This is a one-off for that tax year only and means the tax efficiency of the deceased’s Isa savings isn’t lost when they die.

If you are unmarried or not in a civil partnership, or choose to leave your Isa funds to someone else, then the cash inside could be subject to inheritance tax if your estate is worth over £325,000.

An Isa ends when either the executor closes it, the administration of the estate is completed, or after three years and one day after you have died. Find out more about this in guide to inheritance planning.

What is a cash Isa account? Do I need one? - Times Money Mentor (3)

Is it worth having a cash Isa?

Whether it’s worth having a cash Isa ultimately depends on your circ*mstances and what you’re saving for.

  • PROS:
    • Any interest earned from it is tax-free
    • Money is protected up to £85,000
    • Easy to set up, simple to understand
    • Good for higher earners who don’t benefit from the personal savings allowance
    • Protects against politicians who may remove the PSA in the future
    • Interest rates are high, meaning more savers with normal savings accounts are paying tax on their interest, but interest from cash Isas is not affected
    • The tax-free element is forever, so even if your savings won’t earn £1,000 in interest now, they may in the future
    • Relatively risk-free
  • CONS:
    • Most of us can earn up to £1,000 in interest a year tax-free anyway
    • They come with strict rules like how much you can pay in and when you can take money out

While investing in the markets is a great way to make your money grow, it isn’t without risk and should be for the long-term – after you have built up a comfortable cash reserve of three to six months of outgoings.

Find out more in our beginners guide to investing.

Important information

Some of the products promoted are from our affiliate partners from whom we receive compensation. While we aim to feature some of the best products available, we cannot review every product on the market.

What is a cash Isa account? Do I need one? - Times Money Mentor (2024)
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