ISA vs savings account - What are the differences and which is best? | Freetrade (2024)

Wondering if you should get an ISA or a savings account? You’re in the right place.

Choosing between a stocks and shares ISA (individual savings account) or a general savings account doesn't need to send you up the wall. After all, you can have both.

But understanding the differences between a cash ISA, investment ISA and traditional savings account is a helpful way to really get to the bottom of which will suit your personal circ*mstances.

You may find your ISA serves your long-term savings goals, while your general cash savings account suits your short-term cash needs. Each account has different benefits, and it's up to you to decide which makes the most financial sense for your circ*mstances.

What is an individual savings account?

Ah, the ISA. The investor's bread and butter. It's an account geared towards building savings (funnily enough) and comes with certain tax benefits and a yearly allowance as to how much you can put in.

We'll go through the nuances and flavours of ISAs below but the whole goal here is to help people save and invest in a tax-efficient way, that isn't just stockpiling cash in a bank account.

The UK offers four different types of ISAs. The table below provides a brief outline of the differences between ISAs.

Comparing the types of ISA in the UK‍

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ISAs in a nutshell

One way to think about an ISA is as the tax-efficient cousin to a standard savings account or general investment account (GIA). And while there's a limit on how much you can save into ISAs each tax year (which runs 6 April 2024 - 5 April 2025), once your money or investments are inside you won't have to worry about any UK tax on the interest or dividend income you're paid or profits earned on any investments.

This financial year (2024/2025) has a £20,000 contribution limit. You can plug it all into one particular ISA, or you can spread it across a few different types of ISAs.

Plenty of people choose to split their ISA allowance across both the cash ISA and stocks and shares ISA.

A cash ISA is similar to your ordinary savings account, the difference being you won't pay tax on any interest. So you can think of cash ISAs as tax-free savings accounts.

A stocks and shares ISA lets you invest your money, and again, you won't pay UK tax on interest, income or profits.

A big difference between the two is where these gains come from. When you're shopping around for a cash ISA, you're probably comparing the rates on savings accounts from different providers.

With a stocks and shares ISA, it's the investment options inside the account that will produce gains or losses, not the account itself. Remember, ups and downs are part of investing and when you invest you might get back less than you put in. So, it's not only the account that differs, it's also about the investment risk ladder you climb, in search of higher returns, when you step from the different types of cash accounts into investment accounts.

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ISAs & capital gains tax

It's worth laying out plainly why people use ISAs. For that, we need to look at the tax you might have to pay if you saved or invested, just not using a tax-efficient account.

For the 2024/25 tax year the capital gains tax allowance has dropped from £6,000 to £3,000. That means if you sell assets at a cumulative gain higher than your personal allowance you will have to pay tax on the part above the £3,000.

The rate of tax you'll pay depends on your level of income and which income tax band that falls into.

Basic-rate taxpayers pay 10% capital gains tax, while higher-rate taxpayers and additional rate taxpayers pay 20% in CGT.

There is a quirk if you're a basic-rate taxpayer though. If you add your investment gain to your income and it pushes you from the basic rate band into the higher-rate band, you're essentially considered a higher-rate taxpayer for capital gains tax purposes.

In this case, you'd pay 20% on the amount of your gain that falls into the higher income tax band.

So, while it might seem like a relatively small initial investment pot has little chance of tipping into CGT territory, mighty oaks can grow from some tiny acorns. It's better to plan for that possibility now than get there and wish you had used a stocks and shares ISA all along.

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ISAs & UK dividend tax

Like the capital gains tax allowance, the dividend allowance has also been halved. Previously the first £1,000 of dividends you made were tax-free - now only the first £500 of dividends are.

Once your dividend income goes above this so-called dividend allowance, how much tax you pay depends on the income tax band you fall into.

Basic rate taxpayers pay 8.75% tax on dividend income over the £500 allowance. Higher rate taxpayers pay 33.75% and additional rate taxpayers pay 39.35%.

That's one reason why long-term investors often hold income funds, which pay out dividends, in their ISAs. From an income perspective, it can make sense to make sure those dividends don't attract UK tax, no matter how much they, or the funds, grow.

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Read more

How are my investments taxed?

What is a stocks and shares ISA?

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Differences between an ISA and a savings account

Let's first compare the cash ISA to your everyday savings account.

The most important difference between an ISA account and a savings account is that any interest earned in your ISA is sheltered from tax.

Usually, a cash ISA comes in one of two forms. It will either provide easy access, or fixed-term access.

Easy access is just as it says on the tin, you can access your money whenever you please.

Fixed-term access will only let you do so at the end of the fixed term (say, annually), as decided by your ISA provider.

Regular savings accounts also have a range of different access abilities. Some will let you dip in and out to add or withdraw funds as you please. Others might cap you at a fixed number, and then charge a fee if you go over it.

In an ordinary savings account, tax rules will apply. Though, they depend on a few factors which we've summarised below.

ISA vs savings account

Disclaimer: Comparisons to ISAs are based on our understanding of the gov.uk/individual information as at 16th of April 2024. This is shown for illustrative purposes only. For confirmation of up to date features, you should visit the website.

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When to use a savings account

The above table shows the difference between types of savings accounts. If you want to protect yourself from paying tax on any interest income, then an ISA may be your best choice. But if you want to frequently add and withdraw money, a general savings account may better suit your needs.

That's because you want your savings to keep compounding the interest they achieve over as long a period as possible. Chopping that effect down every so often will stunt the momentum of that snowball effect. So, the period of time you plan to keep money tucked away should have an impact the type of savings account that makes the most sense for you.

When to use an ISA

Remember, if you're saving a larger amount and have a longer-term horizon, an ISA will protect you from ever paying UK tax on any gains.

But if you have a small amount to save with a shorter-term outlook, maybe a savings account is up your alley. The big reason here is that investing is a long-term pursuit. We normally say any timeframe less than five years runs the risk of that compound effect getting caught in market volatility, just when you need the money. In short, you don't want the chance of your investments falling when you go to sell them. In that instance, the relative stability of cash savings may be a better shout.

Cash ISA or individual savings account?

As soon as you hear talk of an ‘individual savings account', just think ISA. They're the same thing after all.

A cash ISA is just one of the four types of ISA.

We outlined the four types of ISA earlier in the article, but we'll now add a bit of colour to another popular individual savings account: the stocks and shares ISA.

Stocks and shares ISA or savings account?

As much as cash may try to convince you otherwise, it isn't always king.

If you're looking to grow your savings and beat inflation, cash is unlikely to be the answer as the interest rates on offer often don't beat inflation. That means you'll be losing purchasing power, in real terms.

Your individual circ*mstances and financial goals will be the biggest factor to consider if you're debating between a stocks and shares ISA or savings account.

When you invest in stocks and shares, you're putting your money to work in the stock market. This is why your long-term return with a stocks and shares ISA could be higher than with a cash ISA.

This is the first way a stocks and shares ISA differs from a cash ISA.

Though, depending on how you choose to invest, it will probably carry greater risk than a cash ISA.

That's because you're investing in the stock market, which means your return could go down or up. There's a risk that you lose all of the capital that you invest, which would be much less likely in the case of a cash ISA.

Both the cash ISA and stocks and shares ISA will protect you from owing tax.

With a stocks and shares ISA, you won't pay UK tax on any investment gains. That means no income tax on dividends or interest earned. You also won't pay capital gains tax if you sell your investments for a profit. Again, you wouldn't pay cash on interest income from a cash ISA but capital gains tax and tax from dividends wouldn't be relevant in that account.

Your Freetrade stocks and shares ISA gives you access to US and UK stocks, ETFs, REIT stocks and investment trusts. So there are plenty of opportunities to diversify your portfolio and scale down or up the risk, as you please.

FAQs

Is a savings account the same as an ISA?

Technically, no. But we appreciate there are a ton of names flying around.

As we said above, an individual savings account is an ISA. This is different from your everyday savings account in a few ways, but most notably, because you won't pay UK tax on interest earned in your cash ISA account.

It's a bit like the Hoover/vacuum cleaner debate. All ISAs are savings accounts but not all savings accounts are ISAs.

A trick if you're trying to distinguish between the two is to just ask yourself, am I sheltered from paying tax on interest in this account? And is there a £20,000 annual deposit limit?

If that's a double head-nod, then you're looking at an ISA.

Can I have an ISA and a savings account?

You can absolutely have both a savings account and an ISA. So if you wanted to tuck away some money for easy access, you could do so with a savings account. At the same time, you could have money saved up in your ISA, so any interest you earn on your savings is tax efficient.

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So, should I open an ISA or a savings account?

As tends to be the way with life, there's no hard and fast rule to answer this one.

But there are a few questions you can ask yourself which might help guide the way.

Let's say you have some cash on hand and you're trying to decide what to do with it. If you've already decided you'd like to save the money rather than invest it, you can choose either a typical savings account, or an ISA.

Then you need to think about tax treatments - just what the tax doctor ordered.

If you want to protect any interest payments from owing UK tax, then an ISA can help here. Bear in mind you might already fall below the threshold of having to pay tax on these interest payments anyhow. Remember our handy table up at the top of the page?

Depending on your relationship with paperwork, the task of completing a self-assessment tax return might make the general savings account more daunting. With an ISA, you don't have to worry about that.

Just remember a stocks and shares ISA is the wrapper. The investments are the filling and it's useful to set yourself at least a five-year timeframe when you invest.

If you have a financial goal in mind before that, it may be that another type of ISA or easy access savings accounts would suit better.

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Read more:

Dividends and your stocks and shares ISA

The (more realistic) ISA millionaire strategy

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Will I go over my personal savings allowance?

If you were earning 1% interest on your savings account, you would need to have £100,000 deposited to earn £1,000 in savings interest.

Still, it's worth double-checking how your savings measure up to your PSA. And if you have a lot of cash in savings, an ISA will guarantee you steer clear of ever paying tax on interest.

It's also important to consider the interest rate on a cash ISA compared to a normal savings account. How do they measure up? This rate will differ depending on the ISA or savings account provider too, so it's a great time to get your research cap on to make sure you're likely to hit your savings goals.

Don't forget that it doesn't actually have to be a choice. You can open an ISA and an everyday savings account if you'd like.

If you do decide to open an ISA, remember that the deadline is midnight on the 5th April 2025.

You won't turn into a pumpkin, Cinderella-style, if you miss it. But you won't be able to take advantage of this year's £20,000 ISA allowance. This is important to keep in mind because you can't carry forward any unused ISA allowances. If you don't use it, you'll lose it.

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How to invest in stocks in your ISA

If you’ve considered the investment risks and weighed them up against the potential benefits of investing in stocks, here’s a straightforward step-by-step guide explaining how to invest:

1. Compare brokerage accounts to decide which one best suits your investing platform needs. Compare our plans to see which one could be right for you.
2. Open a stocks and shares general investment account (GIA) with your broker of choice. Make sure whatever platform you choose has the range of investments and investment products you need. You might want to factor in tax efficiencies and your time horizon, and consider whether a GIA, stocks and shares ISA or self-invested personal pension (SIPP) could help. Once you’ve decided, make your first deposit.
3. Research the type of stocks, ETFs or investment trusts you want to invest in. If you've no idea how to pick your investments have a look at our investment guideswhere you can learn all about which stocks to invest in.
4. Make sure the mutual funds or individual shares fit in with your overall investment strategy, portfolio diversification, personal risk profile, and that the rest of your finances are in a healthy position.
5. Select how much you would like to invest. Think about your portfolio and how you want to balance it between different positions, how much you can invest, and the frequency of investments to help figure out how big or small a holding you want.

Download the Freetrade investment app and join over 1 million UK retail investors that trust us already. See the most popular investments with a breakdown of the most traded stocks and most popular ETFs on Freetrade. Follow the IPO calendar and keep an eye on exciting new investment opportunities.

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‍Important information‍

ISA eligibility rules apply. Tax treatment depends on personal circ*mstances and current rules may change.

A SIPP is a pension designed for you to save until your retirement and is for people who want to make their own investment decisions. You can normally only draw your pension from age 55 (57 from 2028), except in special circ*mstances.

At present, Freetrade only supports Uncrystallised Fund Pension Lump Sums (UFPLS) for customers who wish to withdraw funds from their SIPP after their 55th birthday. We strongly encourage you to seek financial advice before making any withdrawals from your SIPP.
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