Both savings accounts and (cash) ISAs help you save money and pay a small amount of interest on whatever you save. Both offer easy access to savings and can be useful in building up an emergency fund.
But what’s the difference between a savings account and a cash ISA?
There are different types of ISA, cash ISA, stocks and shares ISA, lifetime ISA and junior ISA.
As most people have cash ISAs, that’s what we’ll discuss here.
Savings accounts
Savings accounts come in all shapes and sizes. They include easy access savings, regular savings, notice accounts, fixed rate savings accounts and more.
If you think you may need to access your money, easy access or regular savings would be a good bet.
If you can lock money away without touching it for a few years, a notice or fixed rate account will pay higher rates.
Easy access savings pay lower interest rates but offer the convenience of unlimited withdrawals.
Notice accounts pay higher interest rates but may penalise you if you withdraw money within that fixed period.
You will pay tax on any savings interest over £1,000 per year with any savings account.
I appreciate not many people will have that kind of money in the bank, but it’s definitely something to be aware of.
Most banks and building societies offer savings accounts so you’ll need to compare the best rates to get maximum return.
ISAs
Individual Savings Accounts (ISAs) have been around for almost 25 years but not everyone knows much about them.
ISAs were introduced to encourage people to save. Their main benefit was that you didn’t pay tax on savings interest.
In return, you have an upper annual savings limit of £20,000, which is the maximum you can save in a year.
As you may or may not know, you are allowed to earn up to £1,000 per year in savings interest. That sounds a lot, and it is.
You would need £40-50,000 in a 3.5% interest account to begin earning anywhere near that.
But if you have that kind of money, saving any more in an ISA means you won’t pay savings interest on whatever you save.
What are the rules on ISAs?
There are a few rules you need to know if you want to save in an ISA.
You have that maximum saving rule I mentioned above, a maximum of £20,000 per year.
You can only have 1 active ISA at a time per year. You can keep old ISAs as long as you’re not paying into them and open new ones in new tax years.
Depending on the ISA you have, you may be able to withdraw money from it during the year without losing interest, or you may not.
Which is best a savings account or ISA?
There is no ‘best’ here as savings accounts and ISAs have different purposes.
However, there are distinct differences between the two that makes one more suitable than the other in particular situations.
If you won’t be earning over £1,000 per year in interest, savings accounts pay more interest and have fewer rules.
If you will be earning over £1,000 per year in interest, it’s useful to earn up to that in some kind of savings or investment and put the maximum into an ISA to lower your tax liability.
