Please can you explain how ISAs work?

[sorryIdidntmeanto]

Sorry to be so ignorant, but I can't find the answer online, and it turns out none of my friends know the answer.
I get that in an ISA you can save up to £20000 a year tax free. I think that means that normally you would pay tax on any interest over £1000, but not if it is in an ISA. Correct? I know the £20000 limit is reducing soon.
But why do all ISAs only have decent interest rates if fixed for 1, 2, 3 or 5 years? I had one for a year, but when the interest rate returned to lower than my usual savings account, I closed my ISA, as I wanted to get a better rate.
Is this sensible? Should I now open another ISA? Is it better to keep adding new ISA accounts each year, only this seems complicated.
Maybe it depends how much you are saving. I am thinking of putting away about £5k for a year or two (I feel weird that the bank can access my money but I can't), and keeping the rest in an easy access savings account. I don't have £100ks to worry about, so the difference in interest is not that great.
I am looking at ISAs of about 3.5% and savings accounts of about 2.25%. I really want to keep it all across two providers for simplicity.
Thanks for any insights. My main question is around whether it is better to keep ISAs open after they mature or not. Thanks

Like most savings accounts you get a good rate at the start and then it drops.
You typically get better rates for "fixing" rather than a flexible but the downsides are you can only put money in during the first 7-28 days depending on the product and the money is locked away for the duration. This is one aspect where a fixed ISA is better than a regular fixed savings account as a fixed ISA can be closed and there money returned to you, although you would forfeit the interest.

You are capped with how much money you can put into an ISA in any current year, currently £20k but this is due to change, but not how much you can have in an ISA as long as it is always within an ISA.

For example say in year 1 you put £20k in at a decent rate for 1y. At the end of that year the rate drops. You can then open a new ISA at a better rate and ask this bank to move your existing ISA money into this account. You are then also able to add this year's ISA allowance too. For simplicity I'm going to stick with £20k - now you have in the ISA the original £20k, the second lot of £20k and the interest you earned on the first £20k, say £1000 if it was 5%. You ISA now has £41k

If, however, move the money after 1 year back into your current account whilst you figure out what to do with the money. You then open the second ISA account but you can only put it in the same £20k and not the interest you earned on it. You would now have only £20k in the ISA rather than the £41k

After the isa matures, the best thing to do is to transfer that money to a new isa with a rate you like. You can then add an extra £20k (less when the limits change if you're under 65) in the current tax year.

Example to illustrate
In April 2024 you open an isa with 4% interest. It's a 1 year fix with bank A
In 2024 you save £5k in that isa.
In April 2025 the fix ends and the interest on your isa falls to 0.2%

In April 2025 you open a new isa with 4.5% interest. It's a1 year fix with bank B.
You instruct bank B to transfer the balance from your 2024 isa into your new isa. That money never enters your current account. The new isa provider handles everything. This protects your tax free allowance.
In 2025 you save your full tax free allowance of £20k
This isa now contains £25k you've saved during 2024 and 2025 plus interest

What is your reasoning for keeping to these two banks?
These rates are frankly quite rubbish compared to what you can get 4.5+% for fixed or flexible ISAs.

OP - I highly recommend you look at Rebel Finance School's free course on YouTube. They will talk you through saving & passive investing and introduce you to the magic of compounding!

https://www.moneysavingexpert.com/savings/isa-guide-savings-without-tax/

You can 'fill' an ISA every year and so long as the money stays in an ISA the interest remains tax free. The very best rates are usually for new money (money that hasn't come from an existing ISA).

You can transfer an existing ISA to a different provider after the fix which allows you to shop around for better rates for previous years savings.

Depending on how much you have to save each year it may be better to transfer your ISA when the rate drops rather than closing it.

If you don't have enough in savings to hit the £1000k interest limit for tax then a savings account might give a better rate.

If you are saving £5k for a few years a savings account is probably better. It won't get close to the £1k limit

Thank you. Some great advice.

I just opened a Spring saver account which has a 5% interest rate on balances up to 5k, so that might be an option if you arent worried about hitting the interest tax limit. Its the highest interest rate I could find that isnt a fix (though could reduce at any point to less than 5%)

If you want to keep building the amount that is in ISAs and you want to move to an ISA with better interest or terms it is important that you move money direct from the old ISA into the new.

You open the new ISA, tell them where the money is coming from (the old ISA) and they transfer it, or you transfer direct from the old ISA into the new.

If you withdraw the money into your bank account and pay it into a new ISA that counts as your allowance for that year, so you can't build on it.

MSE always has a table of the best ISAs of different types - fixed / flexible etc.

Each type is explained.

MSE also has tables that show the best savings accounts. You should really be getting 4.25% min.

Thanks, that explains what I wanted to know really clearly.

You are mostly right, that the interest in an ISA is tax free.

Pretty much all savings savings accounts now have a decent rate for a year then plummet. Your money isnt locked away for a year if you choose an easy access ISA. It's only locked away if it's a fixed rate.

Easy access means you can withdraw your money without penalty. Fixed rate means you can't withdraw without a financial penalty.

Even better if you can get an easy access FLEXIBLE ISA which means you can take money out AND put it back in without using up more ISA allowance. Eg if you put the full £20k on this year, then withdrew £5k, you can put that £5k back in by 5th April and it is still considered part of the original £20k you put in.

When the rate plummets after a year or however long you fixed for, you will be given notice. That's when you start shopping around for a new ISA with a better rate.

THE IMPRTANT BIT:
DONT JUST CLOSE YOUR ISA AND TAKE THE MONEY OUT. YOU OPEN A NEW ISA FORST AND ASK THE NEW PROVIDER FOR A TRANSFER IN.

this preserves your £20k plus whatever interest you earned within the ISA and it's still tax free. And you have the new allowance for the new tax year to add on top.
Check that the new ISA allows transfers in and also offers a good rate for transfers, as she gives a different interest rate for new money Vs transfers.
You can open as many ISA s as you like in a taxi year, you can choose one with a good rate for transfers, and a other with a good rate for new money. One can be flexible with a lower rate one not flexible with a higher rate, so you can move money in and out of one but not the other which gives you a better return plus some flexibility.

We have tens of thousands in cash ISAs between us and just move it around every time the interest rate becomes non competitive.

Tesco flexible ISA is the best one at the moment, because if you withdraw some money, it allows you to put it back WITHOUT eating into your annual allowance.

So let's say you have £10,000 in your ISA, you take out £1,000 for something, then you can add £21,000 back in the current tax year.

As pp have said NEVER close an ISA - you must open a new one and transfer the funds across. If you close an ISA and put the money in your current account, for a while, you lose the tax free status. This means you can only save £20,000 this year, whereas if the previous balance was £10,000, you can add £20,000 this year and have £30,000 in there.

Next year the limit drops to £12,000 per annum.

"Next year the limit drops to £12,000 per annum" For cash ISAs, and if you are under 65. Under 65 - you can put the remaining £8k of the allowance into a Stocks and Shares ISA. O-65 - you can still put £20k into a cash ISA,

Stocks and Shares ISAs are not recommended for investment of less than 5 years as the value can drop and rise over time - but the idea is that they do perform better over Cash ISAs over a longer period.

If you’ve got existing cash ISAs and decide you want to make any of them into a longer term investment (ie you’ve also got shorter term savings).you can transfer them into a stocks and shares ISA.