What is the difference between an ISA and savings account?

Let’s start with the most important part of an ISA: how it differs from a general savings account. Though both ISAs and regular savings accounts earn you interest, only ISAs allow you to withdraw your money without having any income tax deducted.

An Individual Savings Account (ISA)

An ISA is a tax-efficient way of investing your money; as long as it stays in the account, you won’t have to pay any income tax on the interest. However, if you take your money out from an ISA, this will be classed as ‘general income’ and subject to income tax. External funds can also be put into ISAs, but they cannot remain in the ISA for longer than 12 months unless they qualify as a short-term or capital gains exemption investment.

When money is placed within an ISA, it does not count towards any annual allowance restrictions that you may have; this includes pensions and self-assessment contributions. The only limitation is on withdrawals as they count towards the annual allowance.

A savings account

A savings account is a current account that pays interest on deposited money and allows customers to withdraw money whenever they wish – although some accounts only offer limited services such as withdrawals or stop payments.

Savings accounts can be created with or without withdrawing money from another current account, and they pay interest on the amount of deposited funds every year. Savings accounts have daily restrictions on withdrawals, but these don’t apply to everyone. Some banks let you make more than three pre-arranged payments per month and unlimited withdrawals for those who hold certain products, such as an ‘overdraft’ credit card product.

There is no limit on where you can manage your savings account from (e.g. not just at a bank branch), and there’s no restriction on transferring between savings accounts owned by different people (e.g. parent and child). The most significant limitation with savings accounts is that the interest earned each year is paid after income tax has been removed, so if you are withdrawing it, you will have to pay tax on what you withdraw.

Savings accounts can be managed online, by phone and post, and there are no restrictions on where you manage the account (e.g. not just at a bank). The interest rates paid on savings accounts can vary greatly; searching through uswitch for ‘savings’ will give you an idea of what types of interest rates are compounded each year for different accounts. Like ISAs, there is no income tax payable on the amount earned from your savings if it stays within the account.

You can also open a savings account with an ISA. This is called a Stocks and Shares ISA (individual savings accounts), and it’s managed by HM Revenue & Customs; customers are allowed to invest into both types of ISAs but cannot put more than £15,000 into one type per year.

Similarities between ISAs and savings accounts:

  • Can hold money for five years before withdrawing it (ISA only)

  • Interest earned within each remains tax-free (ISA only)

  • Cannot withdraw from an ISA without penalty until 5th April of the year after it was opened (ISA only)

  • Differences between ISAs and savings accounts:

  • Withdrawals from a savings account will affect annual allowance restrictions – withdrawals from an ISA will not.

  • Withdrawals from a savings account can be made without prior notice – withdrawals from an ISA must provide 28 days notice.

  • Internal transfers between accounts are easy with a Savings Account – internal transfers are not allowed within an ISA.

  • It is possible to have two savings accounts linked to one another (e.g. parent and child), but it is not possible to link two ISAs together.

Finally

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