Frozen tax thresholds mean increasing numbers of savers could face paying more tax on their savings but there are ways to shelter some of your money from the taxman using an individual savings account (ISA).
Moneyfacts has warned that more than four million people are expected to move up into the higher-rate tax tax band by 2030, which will mean a reduced personal savings allowance (PSA) of £500 compared with £1,000.
Putting your money in an ISA instead means you don’t have to worry about falling foul of the PSA.
All adults in the UK get a £20,000 annual allowance that can be put into an ISA tax-free. That means you don’t have to pay tax to HMRC on any interest or profit earned in the account. The deadline resets at midnight on 5 April – any allowance you’ve not used by then, you lose and a new £20,000 allowance begins.
Using an ISA can be a great way to save towards a goal such as a mortgage deposit or a wedding – or even just to build an emergency fund or put money aside for a summer holiday – without having to share your returns with the taxman.
Now is a good time to act as many providers start offering competitive deals such as high interest rates or cashback as the tax year comes to an end to entice new customers.
There are a few different types of ISA to choose from and some allowances are set to change in the coming years.
Cash ISA
A cash ISA is similar to a savings account. You can choose an easy access ISA that allows withdrawals at any time and may have variable interest rates, or there are fixed rates that pay stable amounts in return for locking your money away for longer. The interest earned on those cash ISAs is fixed for a set period, such as a year or 18 months.
Cash ISAs provide certainty as you know what return you will get and there is no risk of losing your money, but rates are often typically lower compared to normal savings accounts and often the returns fail to beat inflation, which effectively means you are losing money on your savings.
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Currently, you can put all or some of your £20,000 ISA allowance into a cash ISA but this will be restricted to £12,000 from April 2027 as part of government plans to encourage people to invest more.
Charlene Young, pensions and savings expert of AJ Bell, explains: “A cash ISA can only hold cash savings.
“This makes them handy for storing money you might need at the drop of a hat, but they may be vulnerable to the effects of inflation if prices are rising faster than the interest rate it’s paying you.”
Stocks and shares ISA
You can also put your money to work by investing and earning any returns tax-free.
A stock and shares ISA lets you invest some or all of your £20,000 allowance in shares or funds, plus the returns are typically higher than cash and beat inflation, which can be a more efficient and rewarding use of your money and help you reach your savings goals faster.
Young says: “A stocks and shares ISA is an investment account that could grow your wealth and protect it from inflation. They are better suited to longer-term goals, such as investing for school or university fees, to pay off a mortgage, or to boost your retirement pot.”
Holly Mackay, founder of investment guidance website BoringMoney, says a stocks and shares ISA is the “no brainer” place to start for anyone who wants to invest.
She adds: “We can put anything between £1 and £20,000 into this tax-free account every year, but they are also flexible so you can take the money out if you need it. If you’re a bit nervous about investing, you can always start with say £100 and have a cash ISA too. And ease your way in.
“Even the stuffy world of finance is not immune to technology and it’s now easier than ever to open a stocks and shares ISA online. If you don’t really know what you are doing, look at a ‘robo adviser’. They will ask you a few simple questions and guide you into a pre-assembled collection of investments.”
Lifetime ISA
A third option is a lifetime ISA (LISA).
This is a dedicated tax-free savings product that can be used to save money for a mortgage deposit or for your retirement. The LISA pays a 25 per cent government bonus on what you save towards your first home deposit or want to top-up on your retirement fund.
There are a few restrictions though. It is only open to people aged 18-39 and you can only put up to £4,000 into the product each tax year, which comes from your £20,000 allowance. You also need to be purchasing your first home and the maximum value is £450,000.
The Treasury announced that it is considering an alternative to Lifetime ISAs in its 2025 Autumn Budget so this product may also change. A consultation is due this year on replacing the Lifetime ISA with a first-time-buyer focused product from April 2028.
Junior ISA
There is also a separate ISA allowance that you can use to save for your children.
Parents can put up to £9,000 into a cash or stocks and shares Junior ISA account for their children that can only be accessed from the age of 18.
Innovative finance ISA
If you invest in peer-to-peer loans or some types of debt-based crowdfunding, it is also possible to earn returns tax-free.
You will need to check if the peer-to-peer lending or crowdfunding platform you are backing loans through offers an Innovative Finance ISA (IFISA). The returns from peer-to-peer loans you fund and hold in an IFISA can be earned tax-free and it forms part of your £20,000 allowance.
How to use your allowance
You are free to use your ISA allowance across the different types of ISAs, such as spreading your £20,000 allowance across cash ISAs and stocks and shares ISAs.
ISA holders can also transfer their pots from previous tax years to new products paying higher interest. This is also an option if you want to boost your stocks and shares ISA account and keep the tax-free wrapper.
But remember from April 2027, the cash ISA allowance will be reduced to £12,000 and transfers from stocks and shares ISAs to cash will be banned.
Some ISAs may even be termed flexible, which means you can add, remove and replace new contributions during a tax year without impacting your annual allowance.
Rachel Springall, finance expert at Moneyfacts, cautioned: “Not every ISA provider allows this, so savers need to check the terms and conditions carefully. ISA holders must never encash their pots without thinking it through, unless they desperately need the cash, as it will lose its tax-free status.”
When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
