Common ISA myths exposed
Many people misunderstand ISAs, thinking it locks your cash in or that you can only open an ISA at a certain time of year. Below online investment service Nutmeg exposes nine common myths surrounding ISAs and explains how you can take advantage of your annual tax-free savings and investment allowances. See YourMoney.com’s ISA 2016 guide for more information.
1) If I open an ISA my money is locked in for at least a year
Some cash ISAs offer higher interest rates if you lock your money in for a certain time period and if you decide to cash in sooner you may be penalised. However, most cash ISAs and almost all stocks and shares ISAs allow you to withdraw your money whenever you want. It’s worth making a note of any exit charges or restrictions that may apply to withdrawals and look out for how and when your interest is accrued and paid – some pay interest annually, others monthly.
2) ISAs are only for people with lots of money
Some companies will ask for a minimum investment because they don’t want to look after “small clients” but for the majority of ISA providers, there’s no minimum required. There is a maximum allowance though, and for the current tax year, which runs till 5 April 2016, it’s £15,240. You can invest all of that in either a cash or stocks and shares ISA, or both.
3) You can only have a cash ISA or a stocks and shares ISA
You can actually have a cash ISA, a stocks and shares ISA, or both. A Help to Buy ISA is considered a Cash ISA. You can put your whole ISA allowance into either a cash or stocks and shares ISA, or you can split it any way you choose between the two. When the new tax year starts on the 6 April, you can open a new ISA – the allowance remains at £15,240.
4) Cash ISAs deliver better interest rates than other savings options
According to data from the Bank of England, the average cash ISA rate in February was 1.02%. When looking at general savings accounts the rate is very similar but some current accounts are offering as much as 5%. It’s key to read the terms and conditions for any account you open. The attractive rates on current accounts may come with a smaller limit on deposits or the requirement to move your day to day banking. Finally, it’s always important to remember that there are long-term tax benefits to an ISA that a standard savings or current account won’t have.
Stocks and shares ISAs, as with any investment, carry risk: the value of your portfolio can go down as well as up – but the potential return can be far higher than the rate you can get through a cash ISA. Having these savings within an ISA means all gains are exempt from Capital Gains Tax.
5) ISAs are for seasoned investors
It’s often thought that ISAs – especially stocks and shares ISAs – are only for experienced investors. Having a stocks and shares ISA doesn’t mean you need to keep tabs on the financial markets and manage your investment as global stock market prices fluctuate. The development of the internet means financial experts can serve many more customers than was possible under the constraints of face-to-face only service. There are two types of companies that can help you: a DIY stockbroker, where you select your own investments, typically in the form of stocks, shares or a fund or via companies that manage your investments and your role is to guide the company on how much risk they should take on your behalf. The fees for the two options are largely similar.
6) ISAs are complicated
ISA’s were complicated, but they’re not now. ISAs replaced PEPs (Personal Equity Plans) and TESSAs (Tax Exempt Special Savings Accounts). Neither were particularly simple. We’ve also had the brief era of mini and maxi ISAs to further confuse us but they were discontinued in 2008. The current ISA framework is much easier to understand and needn’t be feared by anyone new to saving or investing.
7) Once you’ve opened an ISA you can’t transfer it to another provider
The rules around ISA transfers used to be more complicated and there were restrictions on what kinds of ISA you could transfer and how much. That changed in 2014, and now all restrictions have been lifted on ISA transfers – you can transfer your ISAs from cash to stocks and shares, and vice versa, in any way you choose. And you can transfer between providers – you typically need to fill out a form with your new ISA provider and it’ll take care of the logistics.
8) If I get an ISA I’ll have to do a tax return form
You don’t have to declare income and capital gains from ISA savings and investments or notify your tax office that you have an ISA.
9) The end of the tax year is the best or only time to open an ISA
You can open an ISA at any time. The term ‘ISA season’ has emerged because so many people leave it to the last minute, just before the end of the tax year, to use up their ISA allowance. After the ISA deadline has passed, you lose the tax-efficient allowance for that year for good. Banks and building societies have often used this time to offer improved interest rates to lure savers through their doors.
But, the sooner you open your ISA, the sooner you could be earning returns on your savings or investments. Interest on an ISA is typically accrued daily but paid monthly or annually and if you’re investing into the stockmarket then you benefit from those returns immediately. It’s worth checking the details of how and when your ISA will be invested before opening your ISA to check it’s in line with your expectations.