I’m 27 and want to start saving. Should I open an Isa? I’m in full-time employment and contribute to my workplace pension, but I don’t have much spare cash. What should I do?
Sophie Warburton of This is Money replies: Opening an Isa, or individual savings account, can be an effective way to earn interest or investment returns without paying tax on them.
Although the range of options may seem confusing at first, setting up an Isa usually takes only a few minutes.
The main choices include cash Isas, stocks and shares Isas, Lifetime Isas (Lisas), innovative finance Isas and junior Isas.
With Isa allowances due to change in 2027, now could be a useful time to understand how each type works and decide which best suits your goals.
Isas let you save and invest while protecting your interest, investment profits and dividends from tax
At present, you can deposit up to £20,000 a year into a cash Isa. From April 2027, however, the cash Isa limit will fall to £12,000.
If you want to compare the leading deals, our independent best-buy savings tables list cash Isas by interest rate. Banks and building societies cannot pay to feature in the tables or improve their position.
We also asked financial experts for their guidance on how to balance saving, investing and building an emergency fund.
Charlene Young, head of technical at AJ Bell, says: Before putting money into an Isa, make sure you have dealt with costly short-term debts such as overdrafts and credit cards. You should then aim to build enough cash savings to cope with an unexpected financial shock.
The right amount will vary from person to person, but holding the equivalent of three months’ essential expenses is a useful rule of thumb.
Keep this emergency fund somewhere you can access quickly, such as an easy-access cash Isa or a standard savings account.
The more suitable option will depend on the interest rates available and your income tax position.
Many savers can earn some interest tax-free through the personal savings allowance (PSA). This covers up to £1,000 a year for basic-rate taxpayers and £500 for higher-rate taxpayers. The allowance is removed entirely for additional-rate taxpayers.
Whichever cash account you choose, compare rates carefully and check when introductory or bonus offers expire. You may need to move your money once the promotional period ends.
Investing vs saving: What to consider
Any money you can spare beyond your emergency savings could be considered for long-term investing. Ideally, you should be prepared to leave it invested for at least five years, giving markets time to recover from short-term falls.
Over the long term, history suggests investments offer a stronger chance than cash of growing wealth above inflation. Many people therefore use more than one type of Isa to save and invest, taking advantage of the generous overall allowance.
A common misconception is that investing is only suitable for people with a large lump sum.
In reality, you can begin with relatively modest amounts. Investing £50 a month into a stocks and shares Isa could build to almost £8,000 over ten years, illustrating how regular contributions can add up.
If you decide to invest, setting up automatic monthly payments can make it easier to stay disciplined and continue investing consistently.
You can set up a regular payment into a stocks and shares Isa and decide in advance which specific investments it will go into so that’s also taken care of for you.
A stocks and shares Isa lets you invest tax-free but still have access to your money when you need it.
But if you’re saving for your first home, a Lisa is still an option as you’re under 40.
You can invest up to £4,000 a year and the government tops it up by 25 per cent.
There is a catch though – your first home must be worth £450,000 or less, otherwise you’ll be charged a 25 per cent withdrawal penalty.
Charlene says a common myth that holds people back from investing is how much cash they should have
April Leeson, Senior Chartered Financial Planner at The Private Office says: It’s great to hear that this person is keen to start saving, as the sooner you do, the easier it can be to form a good savings habit which can build a healthier financial future.
It’s also ideal that you are contributing into your company pension scheme, as this will help to give you some income in retirement.
And it means that you are not missing out on your company’s contributions, which is effectively free money.
An easy-to-access cash buffer of savings is the first thing to build up, for those life events and curveballs such as an unexpected car or tax bill.
After that, what you do with your cash savings really depends on what you need the money for and when.
But tax-free Isas are good to consider, as making the best use of the tax allowances available is sensible.
There’s no need to wait until you start saving into an Isa. There is no minimum amount that makes an Isa worthwhile (although there may be a minimum deposit required), so getting started is more important than waiting until you have built up a larger sum.
April says you shouldn’t leave money to languish in a current account
If you are looking to save in order to buy your first home, the Lisa is something to consider.
While there are some features that you should be aware of, mainly a penalty if you withdraw the money for anything other than buying your first home, or after the age of 60, the 25 per cent government bonus alongside tax-free returns makes this a great option for first-time buyers.
It has been reported that the Lisa is to be replaced with a new First Time Buyer Isa in April 2028, but we don’t know all the details yet.
And until then you can still open a Lisa and continue to contribute going forwards.
However, if you might need access to the money in the short term, leaving it in cash might be a more sensible option.
You cannot use a Lisa towards a first home purchase, for at least 12 months.
And if you withdraw the money for any other reason before age 60, you will normally face a 25 per cent withdrawal charge.
But you shouldn’t leave the money to languish in a current account earning no interest, as there are plenty of competitive savings rates available.
> Best Lifetime Isas: The top deals and how they work
When to consider stocks and shares Isa
April Leeson continues: Once your cash buffer is established, it may then be appropriate to branch out into longer-term investments.
A stocks and shares Isa is more appropriate for those who are saving for the longer term, so five-plus years saving, as the funds will go up and down with markets.
But, if you are comfortable with the inevitable bumps in the road and you do not sell when the markets have fallen, over the long-term, a stocks and shares Isa has the potential to provide a higher return than cash, as historically cash returns have often struggled to keep pace with inflation, meaning your savings lose real-value over time.
However, investing isn’t suitable for money that you might need in an emergency.
Any investment into a stocks and shares Isa should ideally be money that you can afford to be without for a few years, as the nature of stock markets means the pot will go down as well as up.
Having cash in the bank that is available in an emergency and does not fluctuate allows you to leave your investments alone and gives them time to recover from any dips in the market.
> The best investing platforms for beginners: Our expert picks the top options
There are various places that will offer some guidance as to which funds to use, but a low-cost investment platform could be suitable whilst funds are building.
stocks and shares Isa Isas come with costs though, whilst cash Isas don’t usually cost anything to open or maintain.
There is also nothing to stop you using more than one type of Isa, as long as you keep within the annual Isa allowance which is £20,000 (which includes anything saved into a Lisa).
Putting some money into a cash Isa and some into a stocks and shares Isa Isa could be a sensible way to diversify your savings between accessible cash and longer-term investments.
You don’t need to have a huge amount of money before you start saving or investing.
Starting early, saving regularly and choosing the right home for your money based on when you might need it are much more important.
