What You Need To Know About ISAs

What You Need To Know About ISAs

Making our money work harder is something we’re all keen to do – whether it be through well-timed investments or building up dedicated savings. ISAs are one of the most popular financial products on the market today – but it’s critical to understand the basics to ensure it’s the right choice for you. Here, the experts help us answer some important questions…

First, what exactly is an ISA?

Standing for ‘‘individual savings account’ ISAs are tax-efficient savings and investment accounts which can be used to save cash or invest in stocks and shares. Simply put, you should think of an ISA as a savings or investment account on which you never pay tax during your lifetime. Chris Harrington from accountancy firm Cowgills explains: “Each tax year, you get an ISA allowance which sets the maximum you can save within the tax-free wrapper from April to April.” For the current tax year of 2020/21, this is £20,000.

How many ISAs can you have at one time?

As long as your total tax-free savings in 2020/2021 don’t exceed £20,000, you can split them across a combination of cash ISA, investment ISA, lifetime ISA or innovative finance ISA savings, says Chris. However, they would have to be different types of accounts. “This means that while you can’t subscribe to two cash ISAs in the same tax year, you can have more than one ISA per year – they just have to be different types.”

So, there are different types of ISA – can tell us a bit more about each one? 

Cash ISA: “This is just like an ordinary savings account although you are never taxed on the interest,” explains Chris. “There are a variety of cash ISAs available, including instant access, regular savers and fixed-rate deals and you don’t have to pay to open a cash ISA. A fixed-rate cash ISA can pay a guaranteed amount of interest over a fixed period of time, which can be attractive to investors who want to know what they are getting. This is possibly the reason around 80% of all ISAs are saved into cash, but they do tend to be the ISAs which pay the lowest interest rate so they might not be the best option for a long-term investment. Many fixed-rate cash ISAs are easy access so they’re also attractive to those who think they might need funds at short notice.” 

Help To Buy ISA: “Essentially, these were cash ISAs aimed at helping first-time buyers get a foothold onto the property ladder,” says Chris. “The Help to Buy ISA enabled you to invest up to £1,200 in month one, then a further £200 a month. When the funds are used to purchase your first home, the government will boost your savings by 25% up to a maximum of £3,000. Since 30th November 2019, these have been closed to new applicants and no further deposits were permitted since that date. Deposits can continue to be made to existing Help to Buy ISAs until 2029. If you didn’t get one in time, Lifetime ISAs also offer a 25% bonus for first-time buyers.”

Lifetime ISA: Launched in April 2017, these can help you save money either to buy a home or for retirement. “At £4,000 a year the lifetime ISA (LISA) has a higher annual maximum contribution than the Help to Buy ISA and gives interest from day one, with a bonus of 25% which is paid monthly,” explains Chris. “You must be under 40 to open one, and the bonus is paid until the age of 50. Therefore, effectively for every £4 you save up to the time you reach 50, the government will give you £1. Once you reach 60, you can take out as much as you like tax-free. If you take money out before age 60, you would lose the government bonus and the interest on that bonus. However, if you withdraw from the LISA specifically for a deposit for buying a first home you will not be penalised, and you can retain the account and keep saving in it for your retirement.”

Investment ISA: Also known as stocks and shares ISAs, an investment ISA usually involves putting your ISA into the hands of a fund manager or an online service to invest into a variety of different bonds and shares, or tracking the FTSE 100 index on your behalf. “There is no capital gains tax (CGT) payable on profits coming from share price increases and you don’t have to pay tax on interest earned from bonds,” says Chris. “If you invest outside an ISA, any profits made above the annual CGT allowance (£12,300 for 2020/21) would be subject to tax at 10% for basic-rate taxpayers and 20% for higher-rate and additional-rate taxpayers.” It’s also important to recognise most investment ISA providers charge fees and management charges. Look at this kind of ISA as more of a long-term investment, as shares can go down as well as up, making it riskier than a cash ISA.

Innovative Finance ISA: An innovative finance ISA (IFISA) lets you use your tax-free ISA allowance while investing in peer-to-peer (P2P) lending. “With an IFISA, you become a lender, investing in individuals, property or businesses in return for a set amount of interest based on the length of time you are prepared to leave your money untouched,” says Chris. “With an IFISA, interest from lending to others is not taxed, though it is a riskier proposition than a cash ISA as there can be less of a guarantee you’ll get your money back. Not all P2P lenders are authorised by the Financial Conduct Authority (FCA), or given ISA Manager status by HMRC, which can be an issue. If the IFISA is regulated, investments can be held tax free. If not, interest would still count as part of the PSA.”

Junior ISAs: Junior ISAs allow you to save tax efficiently for your children. As The Money Advice Service explains: “Family and friends can put up to £9,000 into the account on behalf of the child in the 2020-21 tax year. There’s no income tax or capital gains tax to pay on the interest or investment gains, and junior ISAs are available to any child under 18 living in the UK who doesn’t qualify for a child trust fund.” Your child can have a junior cash ISA, a junior stocks and shares ISA or both. If they have both, the most they can save is still subject to a limit.

What’s the advantage to having a cash ISA instead of a normal savings account?

According to Chris, this is a common question posed by savers, and the answer largely has to do with interest rates. “Since the personal savings allowance (PSA) was introduced in 2016, basic rate (20%) taxpayers can earn up to £1,000 interest a year tax free while higher rate (40%) taxpayers can earn up to £500 interest a year tax free on savings accounts. Interest from ISAs doesn’t count towards your PSA, so a rise in interest rates could give you a lot more interest from an ISA than from an ordinary savings account.”

Is it possible to have more than one ISA at a time?

You can split your annual £20,000 contribution between the different ISAs however you like – just bear in mind you can only contribute to one of each type of account at a time in each tax year. While some providers now offer ‘split’ ISAs with a variable rate and a fixed-rate cash ISA in the same account, it is possible to keep the previous year's ISA open, transfer it to a new provider and change the investments held in them. 

How can I move my ISA to a better provider?

It is possible to transfer your ISA between different providers without reducing your annual allowance. For example, if you put £5,000 into a cash ISA last year and want to move it to a new bank which is offering a better interest rate, you can do so while still paying £20,000 into a new ISA this year, too. You can also move money between cash ISAs and stocks and shares ISAs – although you might find certain providers insist on transferring the whole account and charging a fee. It’s also important to remember that if you want to move your ISA, you must make a formal transfer request through the new provider. Otherwise, taking the money out will count as a withdrawal.

What are the rules when it comes to withdrawals?

Making cash withdrawals won’t lose you any tax benefits, but you should always check the terms of your ISA to see which penalties apply. It’s also likely you’re ISA comes with an access stipulation (remember not all ISAs will offer flexible arrangements) – as Legal & General’s personal investing team explain below:

Instant Access: "With an instant access cash ISA, you can withdraw money when you want without any restrictions. So, if you think you’ll need funds at short notice, this may be your best option.”

Fixed Rate: “With fixed term cash ISAs, you lock your money away for a set period in return for a better interest rate. While you can withdraw money from a fixed rate ISA, you will usually have to pay a penalty. Typically, you will lose a set number of days’ interest, usually 60-120 days.”

Flexible: “New rules that came into effect in April 2016 mean that if your ISA is flexible you can withdraw money and replace it during the same tax year without it affecting your current year’s allowance. Say you deposit the full £20,000 and then take out £5,000, you can replace the £5,000 at a later date in the same tax year without breaching your allowance, even though you will actually have deposited £25,000 in total.”

Flexible Fixed Term ISA: “You can make a limited number of cash withdrawals, typically up to 10% of the balance.”

For more information, contact The Money Advice Service, or consult the official government website here.

*DISCLAIMER: Anything written by SheerLuxe is not intended to constitute financial advice. The views expressed in this article reflect the opinions of the individuals, not the company. Always consult with an independent financial advisor or expert before making an investment or personal finance decisions. 

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