ISAs or savings accounts: Which is right for you?

When you know what you want to save for, the next step is to understand which type of account best suits your goals. For many people, this means comparing ISAs vs savings accounts to find the right fit.

One of the main differences between ISAs and savings accounts is how they are taxed. Interest earned on deposits in a savings account is liable for tax when it exceeds your Personal Savings Allowance (PSA). In contrast, money in an ISA remains completely tax-free regardless of how much interest you earn.

But what else do ISAs and savings accounts offer, what are all the differences, and what should you consider when deciding between an ISA or a standard savings account?

An Individual Savings Account (ISA) allows you to earn interest without paying tax.

Everyone in the UK has an annual ISA allowance, which is £20,000 for the current tax year. You can choose to use this allowance in one type of ISA or split it across different types.

The main types of ISAs are:

• Cash ISAs: This functions like a savings account, but all your interest is tax-free.
• Stocks and shares ISAs: An investment account where your returns are protected from tax. When comparing a stocks and shares ISA vs a savings account, it is important to remember that investment value can go up or down and you may get back less than you put in.
• Innovative finance ISAs: Accounts that allow you to earn tax-free interest through peer-to-peer lending. Peer-to-peer lending involves investing in corporate debt, meaning your capital is at risk and these accounts are not protected by the Financial Services Compensation Scheme (FSCS).
• Lifetime ISAs: Accounts designed to help you save or invest for your first home or for retirement. The accounts offer a government bonus dependent on the amount you save, but a 25 % government withdrawal charge applies if you withdraw funds for any other reason, meaning you could get back less than you put in.

A savings account is a deposit account held at a bank or building society that provides a place for your money while earning interest. Depending on the type of account you choose, you may be able to access your funds whenever you need them, or you might lock them away for a set period to receive a higher interest rate.

Some of the most common types of savings accounts include:

• Notice accounts: You can make withdrawals after a set notice period, typically between 30 and 95 days. They typically offer variable interest rates and provide the flexibility of an easy access account with more competitive interest rates.
• Fixed rate bonds: When depositing a lump sum, you receive a set return over a fixed period, usually between six months and five years. Interest rates on fixed term savings are often better than notice or easy access savings accounts and are typically more competitive when the term is longer
• Easy access savings accounts: You have the freedom to deposit and withdraw money flexibly, with minimal restrictions. Interest rates will typically be less competitive than those on notice accounts or fixed rate bonds.

While both options can give you a secure place to grow your money, they operate under different rules. The table below outlines the main differences to help you decide which account might suit your savings goals.

A fixed rate bond can sometimes provide a slightly higher interest rate than a comparable cash ISA. If your interest earnings remain within your PSA, a fixed rate bond could give you a higher overall return.

However, if you have a large amount of savings and expect to earn more interest than your allowance, this is when an ISA might be more suitable. Even if the advertised interest rate is slightly lower, the tax-free benefits can mean you keep more of your earnings in the long run.

It’s always important to compare current rates and consider whether you will need access to your funds before you open an account. You should also consider your personal circumstances and savings goals.

Yes, you can hold both types of accounts at the same time. In fact, many savers choose to use a combination of the two to build a balanced financial strategy.

Using both allows you to make the most of your tax-free allowances while potentially also accessing more competitive interest rates. 

It does not have to be an either-or decision. By comparing all your options, you can find the right mix of accounts to suit your financial goals.

Deciding whether to open an ISA or a standard savings account ultimately depends on your personal needs and financial goals. It does not have to be an either-or decision. By comparing all your options, you can find the right mix of accounts to suit you.

ISAs tend to be popular for longer-term savings because they protect your money from tax year after year. This can be especially beneficial if you have a larger sum to deposit and want to use your tax allowances.

Standard savings accounts are often used for short-term goals and earning a higher interest rate to maximise your PSA. You can typically find more competitive interest rates on a traditional fixed rate bond or notice account. Since many savers do not reach the threshold for paying tax on their earned interest, a standard account can be an effective option for growing your money.

Here’s an example to help demonstrate this. If you deposit £20,000 into a fixed rate bond offering a 5.00% AER interest rate, you would earn exactly £1,000 in interest over the course of a year. This is the maximum you can earn before paying tax as a basic-rate taxpayer. If you are a higher-rate taxpayer, you would reach your tax-free limit with a deposit of £10,000 at an interest rate of 5.00% AER. When choosing the right type of account for you, work out how much interest you will earn and whether this will exceed your PSA. 

If flexibility is important to you, some savings accounts also let you make withdrawals and top up your funds whenever you need to. By understanding what you want to achieve, you can choose accounts that align with your plans.

Although we don’t currently offer ISAs at Raisin UK, you can compare and open other types of savings accounts from our partner banks and building societies through our marketplace.