High interest account or ISA?

[DustyLee123]

DD has a couple of thousand pounds that she wants to save, maybe as a house deposit or for a car etc, in the future.
We looked at ISA’s and bank accounts, and the highest interest she was getting was from an account, not an ISA, so she put it in there. Are we going wrong somewhere, as I see lots of people saying ISA’s are better?

What about a stocks and shares ISA? I have one with Moneybox and currently it’s getting 10%!

I believe S&S is more risky than a standard ISA? She wants to put it away and forget about it, and at least come out with what she put in.

Interest paid on ISAs is tax free. Interest on non-ISAs is paid free of tax but tax might be due on it if your total income from interest is over a certain amount in that financial year. For most people the limit is £1,000 of interest and for higher rate tax payers it's £500.

As your DD only has a couple of thousand in savings, the interest on that will be less than the threshold to pay tax on it, so she is OK in the higher paying non-ISA.

She’s a student, so not paying tax.

What about LISA? If she's saving towards a house deposit, gov bonus of 25% and usual ISA interest of approx 4%.

If she’s a student without property then the help to buy ISA (I think it’s still called that) will give her a 25% government top up so it’s worth using that

She doesn’t want to lock it into house buying, she wants to be able to use it for whatever.

Yes, investments are more risky than savings accounts. You can lose the capital (the amount you originally put in) although if you stay in for long enough it will probably recover. But that's problematic if you want/need withdraw money at a particular time - if your investment has fallen it might be worth less than you invested and you've actually lost money.

I have experience of that: invested in S&S ISAs around the year 2000, the value dropped shortly after and for several years they were worth less than I'd put in. And I mean years, not just a few bumpy months.

What you get from an ISA is that you don’t pay tax on the interest.

So it depends on whether you have enough savings to go above your tax-free allowance for interest payments.

If you're a basic rate tax payer, you can earn £1000 in interest before you have to pay tax on it. So if you have less than £20k in a 5% interest bank account, you're fine. Above that allowance you pay tax on the interest at your marginal rate. Ie if a basic rate had £40k in a 5% interest bank account, she would pay a total of £200 tax. She's still getting 5% interest on the first £20k of savings, but she's effectively only getting 4% interest on the other £20k savings. The other 1% (£200) goes in tax.

It's more of an issue if you're a higher rate tax payer or have more savings.

If you're a higher rate tax payer, the allowance goes down to £500. So if you have more than £10k in a 5% interest bank account, then you would start paying 40% tax on the interest for all your savings above that. Which would bring the effective interest rate down to 3% for your savings above £10k (60% of the 5% interest)

In an ISA, you don't pay tax on the interest, no matter how much savings you've built up.

So if she only has a couple of thousand, then no need to put it in an ISA. If she's expecting to build it up quickly over the next few years, then she might want to think about timing to put it into an ISA since you're only allowed to put in a maximum of £20k per tax year.

So if she only has a couple of thousand, then no need to put it in an ISA

thanks, this is what I needed to know.

If she wants to be able to forget about it without the bother of checking whether her variable rate has dropped and potentially having to move it to another account from time to time, she might consider fixed rate savings (bond) for a year or two or however long she is willing to lock it away for.