How Does an ISA Work?

The simple version

An ISA is a protective wrapper you put around your money. Inside the wrapper, your money grows tax-free — you don’t pay tax on interest earned, investment returns, or dividends. And when you take money out, you don’t pay tax on that either.

Without an ISA, interest on your savings and returns on your investments are taxable income. With an ISA, the taxman can’t touch any of it.

What is the ISA allowance?

Each tax year (which runs from 6 April to 5 April), you can put up to £20,000 into ISAs. This is the annual ISA allowance. It resets every year — if you don’t use it, you lose it.

Once money is inside your ISA, it stays protected from tax indefinitely — no matter how much it grows or how many years pass. The allowance only limits what you can add each year, not how much you can hold.

Cash ISA vs Stocks and Shares ISA

There are two main types:

• Cash ISA: Works like a regular savings account, but the interest is completely tax-free. Rates are often competitive with ordinary savings accounts. Low risk — your money doesn’t go up or down.
• Stocks and Shares ISA: Lets you invest in shares, funds, bonds, and other assets, all sheltered from tax. Returns can be higher over the long term, but the value can fall as well as rise.

You can split your £20,000 allowance across both types in the same year — you’re not restricted to one.

ISAs and the Personal Savings Allowance

A separate government allowance — the Personal Savings Allowance (PSA) — already lets basic-rate taxpayers earn up to £1,000 in savings interest per year tax-free outside an ISA (£500 for higher-rate taxpayers; nothing for additional-rate taxpayers). The ISA allowance exists alongside this.

Unlike the PSA, there is no cap on how much can accumulate inside an ISA over time — the £20,000 only limits how much can be added each year. Money already inside an ISA is sheltered from tax indefinitely. Full details are on gov.uk/individual-savings-accounts.

The Lifetime ISA — briefly

There’s also a Lifetime ISA (LISA) for people aged 18–39. You can put in up to £4,000 per year (this counts towards your £20,000 allowance) and the government adds a 25% bonus — up to £1,000 per year. It’s designed for first-time buyers or retirement saving, and comes with a penalty if you withdraw the money for anything else.