Cash ISA or savings account: Understanding the differences

One of the biggest differences between Cash ISAs and other savings accounts is how they‘re taxed. Each tax year (which runs from April 6 to April 5), you’ll receive a tax-free allowance for ISAs, currently £20,000 in combined deposits.

As long as your combined deposits across ISA products (Cash ISAs, Stocks and shares ISAs, Innovative finance ISAs or Lifetime ISAs) are within this limit, you won’t have to pay any tax on the interest you earn or any investment growth within the ISA wrapper. Savings accounts outside of an ISA wrapper do not automatically get this tax advantage.

Depending on your Personal Allowance, your starting rate for savings and your Personal Savings Allowance and the amount of interest you earn, you may need to pay Income Tax on interest income from a non-ISA savings account.

Before we compare Cash ISAs vs savings accounts, we’ll run through a quick overview of each.

 

What is an individual savings account (ISA)?

ISA is an acronym that stands for individual savings account.

There are four types of ISA available. They are:

• Cash ISAs
• Stocks and shares ISAs
• Innovative finance ISAs
• Lifetime ISAs

At Shawbrook, we have Cash ISAs available as easy access cash ISAs (when you can withdraw at any time) and as fixed rate cash ISAs (when you can’t access your money until a certain date).

You can also get notice cash ISAs which require you to give a set amount of notice when you want to withdraw your funds.

It’s important to note that if you make a deposit into an ISA within a tax year then make a subsequent withdrawal in that same tax year, the funds will leave the tax wrapper but will still count towards your ISA allowance for that tax year*.

You can choose to use all your allowance in one ISA or split it across different types of ISAs. However, you can’t invest in more than one of the same type of ISA (i.e. two cash ISAs) within the same tax year. **

You can’t carry over your allowance into future years, but the tax-free benefits are cumulative. For example, you cannot invest £35,000 in one tax year because you only invested £5,000 in the previous one. However, you won’t have to pay any tax on your funds for years to come as long as you leave the money within the ISA wrapper.

For more information, visit our guide on how ISAs work.

 

What is a savings account?

There are various types of savings accounts. All of them help people save money and pay a level of interest based on the amount you have in the account.

The types of savings accounts available include:

• Easy access savings — These allow you to access your money at any time so you can earn interest without locking your funds away.
• Notice accounts — These require you to give notice before withdrawing your money.
• Fixed rate bond — Also known as a fixed term savings account, this type prevents you from accessing your money until it reaches maturity (the end of your agreement).
• Regular savings account — Sometimes called a regular saver, this involves investing a certain amount of money each month.

When deciding between accounts, you should consider the different characteristics such as flexibility and interest rates. In general, you are more likely to earn a higher rate of interest when you lock your money away for a set period.

 

What’s the difference between an ISA and a savings account?

Several things distinguish an ISA from other types of savings accounts.

 

Tax benefits

Tax-efficiency is the most obvious difference between an ISA and other savings accounts.

As mentioned earlier, the current tax-free ISA allowance for this year is £20,000 per person.

Although other savings accounts do not have the same allowance, earning interest in a standard savings account and not paying tax is still possible. However, it is more complicated and not available to everyone.

You can save in a standard savings account without paying tax if the interest you earn falls within your Personal Allowance (how much you can earn in total, including wages, before you pay tax), the starting rate for savings (an allowance only available for those with an income lower than £17,570), or your Personal Savings Allowance (currently £1,000 for basic rate taxpayers and £500 for higher rate taxpayers).

In comparison, the tax-free ISA allowance of £20,000 applies to all regardless of their income, tax band or any other non-ISA savings.

 

Deposit limits

There is no limit on the amount of money you can deposit in a standard savings account. However, banks and building societies may choose to put a cap on the amount you can hold with one account. At Shawbrook, you can hold up to £2,000,000 in a fixed term account.

With an ISA, you can only pay a maximum of £20,000 per tax year. This limit applies across all the ISAs you hold. However, if you transfer previous years’ ISA funds into a new cash or investment ISA, this won’t count towards the current year’s allowance. Read our dedicated page for more information on transferring an ISA.

 

Account limits

You can open as many savings accounts as you like.

You can hold multiple ISAs, but you can only invest in one of each type within a single tax year. So, within the same tax year, you can deposit into a cash ISA and a stocks and shares ISA but you can’t invest in two separate cash ISAs.

 

In summary

Whether a Cash ISA or a standard savings account is best for you will depend on your circumstances. People often choose to invest in ISAs for long-term larger investments and use other savings accounts for smaller short-term savings. However, you should make the decision based on your unique needs and budget. There are a variety of options on offer. You should consider every element of an account, including flexibility, interest rate, tax-free benefits and the service of the bank or building society.

_{*For example: you deposit £1,000 into an instant access cash ISA. You’ll still have £19,000 left to deposit in the tax year. If you withdraw £500 from the balance in the same tax year, you’ll reduce your balance inside the tax wrapper to £500 and you’ll still only have £19,000 left of your ISA allowance.}

_{**If you deposit £2,000 into a Fixed Rate Cash ISA which does not allow additional deposits, you will not be able to pay into any other type of Cash ISA for that year. So it is important that you consider your options carefully.}