Everything you wanted to know about ISAs…but were afraid to ask
The new tax year is less than a fortnight away and for ISA savers or investors, it’s hugely important. If you’re new to ISAs, here’s what you need to know.
The 5th of April is the end of the tax year, while the 6th April marks the start of the new 2023/24 tax year.
While the move from one day to the next may seem insignificant, for savers and investors it’s hugely significant. And one of the major reasons is because of the ISAs ‘use it or lose it’ status.
What are ISAs?
ISAs are Individual Savings Accounts which protect your cash, interest and earnings from tax. It’s best to think of these products as having a special tax wrapper so HM Revenue & Customs can’t get its hands on the money saved or invested in them – or any gains made – and this applies year after year.
And if you usually file a tax return, there’s no need to declare any of this income or earnings on the self-assessment form.
What is the allowance?
Now, adults currently have a £20,000 annual allowance, while children have a £9,000 allowance as part of the Junior ISA (JISA). But this allowance re-sets each tax year – there’s a fresh £20,000 and £9,000 allowance in the new tax year as confirmed in last week’s Spring Budget. But it doesn’t rollover, so if you don’t use it, that allowance is lost forever.
According to the latest Government statistics, there are 27 million adult ISA holders, with 12 million subscribed to in 2020/21 with £72bn ploughed into them.
What are the different types of ISA?
On their own, ISAs are a relatively simple product in that there’s no tax to pay on your cash. However, there have been big changes to ISAs in recent years and the rules around what you can and can’t do with them can make ISAs seem complex.
The main two ISAs are cash (for those aged 16+) and stocks and shares (for those aged 18+) and you can have one of each of these in any given tax year, that is, deposit money into them. HMRC describes this as ‘subscribing’ to an ISA so putting money into them, but the reality is that adults can hold a number of ‘old’ ISAs from different providers going back many years but only pay into one each of these ISAs (more on this below).
When it comes to cash ISAs, much like ordinary savings accounts, you have a choice of easy access, a notice account or fixed term where you can lock away your money for longer in return for a higher rate of interest.
How does a stocks and shares ISA work?
Those comfortable with investing can go down the stocks and shares ISA route, with accounts available via investment platforms, robo or digital wealth managers, via banks’ own investment hubs as well as stockbrokers or financial advisers.
Here, it’s important to note that investing carries risk, so while you hope to beat the return available on cash as well as double-digit inflation, there is a chance you could lose all your money, which is why you need to be comfortable with the risks and volatility that comes with investing in stock markets.
While you can’t control stock market movements, you can control the fees you pay to buy, hold and trade. With around 4,500 funds available to UK investors, a number of platforms and differing price models, its essential to compare fees.
Typically, platforms levy a percentage fee model which is better for investors with modest sums, while others have a flat fee which is better for investors with larger pots.
Check and compare annual management charges, ongoing charge figure and trading charges. It can make a huge difference from paying say 0.1% or 1%.
What are Junior ISAs (JISAs)?
Launched in November 2011, JISAs are aimed at under 18s, helping lay the foundation for their financial future. A parent or legal guardian can open a JISA at a bank or building society on behalf of the child, or they can select stocks and shares as part of an investment ISA, though anyone can contribute to them.
While the child can take control of the ISA at the age of 16, they can’t get their hands on their money until they turn 18.
The beauty of investing for children is that they have time on their side and even small, regular contributions over 18 years can make a huge difference to their financial futures.
Now, many people may not know that children who earn £100 or more interest a year from cash gifted by a parent are subject to their parent’s marginal tax rate so JISAs do away with this.
Around 940,000 JISA accounts were subscribed to in 2020/21, with £1bn added, 57% of which was in cash.
One of the quirks of the JISA is that at the age of 16 and 17, a child can have both a JISA and an adult cash ISA, which means they have an annual total allowance of £29,000.
Another point to note is that with JISAs, you can only hold and contribute to one of each a cash and stocks and shares ISA so if you want to switch provider, these pots have to follow you. This is different to the adult ISA rules where you can subscribe with a different provider each year while you can leave your existing ISA money where it is.
What is a Lifetime ISA?
Affectionately known as LISA, the Lifetime ISA was introduced in April 2017 for people aged 18-39. It’s a hybrid scheme for savers looking to buy their first home up to the value of £450,000 nationwide, or for later life.
It allows a maximum of £4,000 to be deposited each year – in cash or stocks and shares – until the day before the account holder’s 50th birthday where the Government adds a 25% bonus (maximum £1,000 a year).
Now, if you’re saving over the entire period, you could put away £128,000 with the Government adding £32,000 to your savings.
There’s no maximum monthly contribution; you can save as little or as much as you want each month as long as you don’t exceed the £4,000 a year limit.
A LISA needs to be open for at least a year before you can take advantage of it, with a big withdrawal penalty for anyone accessing cash in the first 12 months of opening, or for a reason other than buying a first home or for retirement from the age of 60.
Early withdrawals are subject to a 25% penalty, which sounds like the Government just clawing back its bonus. But actually, this is applied on the whole amount so it eats into your contributions.
As an example, someone with £4,000 saved, with the £1,000 Government bonus would face a penalty of £1,250 for early access.
According to official Government data, £33m was paid in early access charges in 2021/22, with £34m clawed back in 2020/21.
If you and a partner are first-time buyers looking get on the property ladder and you each have a LISA, HMRC confirms you can both use the bonus to buy a property as long as it’s valued up to £450,000.
The LISA allowance also forms part of the overall annual ISA allowance and HMRC confirms that the Government bonus doesn’t count towards the £4,000 LISA allowance, or the £20,000 ISA allowance. This means technically you can actually have £21,000 in these ISAs without breaking the rules.
Waht is an Innovative Finance ISA (IFISA)?
An IFISA is an ISA where you don’t pay tax on interest made from peer-to-peer lending (P2P). These are loans that you give to other people or businesses without using a bank, as well as ‘crowdfunding debentures’ where you invest in a business by buying its debt.
These are considered riskier as P2P lending works by matching up investors – who are willing to lend – with borrowers, who could be individuals, businesses, or property developers, and so investors are reliant on borrowers repaying the loans and not defaulting.
The industry has increasingly come under the spotlight from the regulator, the Financial Conduct Authority, with strict rules around who can invest in them and around the marketing of these ISAs.
And over recent years, a number of big players in the market have pulled out: Funding Circle, Ratesetter and Zopa.
When it comes to the safety of your money, platforms are obliged to ringfence their assets from investors’ money, so if a P2P platform went bust, investors should still receive their investment returns provided the loans don’t default.
If borrowers do default on payments, there’s no protection in place and you could lose some or all of your money.
What are the golden ISA rules?
You can deposit money into one each of the following in one tax year, with the maximum £20,000 allowance (£4,000 for LISA):
- Cash ISA
- Stocks & shares ISA
- Lifetime ISA
- Innovative Finance ISA (IFISA)
There are no restrictions on holding or transferring previous years’ ISAs so adults can have a number of different ISAs from different providers from a number of years ago. But there is a rule around ISA transfers in the current tax year and this is that they must be transferred in full. There’s no such restriction after the current tax year has ended.
As above, when it comes to JISAs, the rules are slightly different as children can only ever have one of each cash and stocks and shares ISAs which follows them from one provider to the next, so there’s no chance of children having several different ISA pots with different providers from different tax years.
When it comes to transferring ISAs, never simply withdraw the funds and place them with a provider. Instead, it’s essential to complete a transfer form from the receiving provider. This is so the cash retains its tax-free status.
ISA transfers should take no longer than:
- 15 working days for transfers between cash ISAs
- 30 calendar days for other types of transfer.
Aren’t there other types of ISAs?
Yes, there’s also the Help to Buy ISA, something called a portfolio ISA and a flexible ISA. We’ll look at these in turn…
What is a Help to Buy (H2B) ISA?
The Help to Buy ISA (the earlier incarnation of the LISA) was launched in 2015 giving people (16+) saving for their first home a 25% boost from the Government, so for every £200 saved, the Government contributes £50.
It closed to new applicants in November 2019 but for those who’ve already opened one before this date – estimated at 2.5 million people – you can continue saving into it until 30 November 2029.
As a recap, it allowed applicants to save up to £1,200 in the first month and then up to £200 a month after that with a maximum saving of £12,000 by the individual which could attract a maximum Government bonus of £3,000.
The H2B ISA can be used on properties up to the value of £250,000 across the UK or £450,000 in London.
And it’s these property price limits which have been criticised in recent times as house prices have soared. Some people are questioning whether Help to Buy ISAs are worth it, while these professional sisters lost their £4,000 Government Help to Buy ISA bonus as they couldn’t buy anything within the £250,000 outer London limit. Unlike the LISA, withdrawals from the H2B ISA aren’t subject to a penalty, but it means you won’t get the Government bonus.
The Government bonus contributes to your overall upfront deposit, increasing the size of your savings for a first home, known as the ‘mortgage deposit’ rather than an ‘exchange deposit’ which is money your conveyancer pays to the seller’s conveyancer.
So, although similar to the LISA, the H2B ISA has a lower contribution and bonus amount, lower property limit outside of London, doesn’t have an upper age limit and is more flexible in terms of withdrawals. It’s also purely a cash product so you can’t invest in a H2B ISA like you can with a LISA.
If you contribute to a H2B ISA in any given tax year, then that will count towards your overall ISA allowance and you’ll likely not be able to pay into a cash ISA in the same tax year (see portfolio ISA below for more information on this).
Savers can have one of each a H2B ISA and a LISA, but you can only use the Government bonus from one scheme if buying a first property.
When it comes to couples, you can also both use the Government bonus from a H2B ISA to get on the property ladder.
And if you’re a couple with one half holding a H2B ISA and the other holding the LISA, HMRC confirms that as long as you’re both first-time buyers, you can use the bonus from both schemes.
What is a Portfolio ISA?
Portfolio ISAs allow you to split your ISA allowance between multiple ISA products with the same provider. Usually you can only open one cash ISA with a provider each tax year as per the rules.
But you may want to have a mix of cash ISAs split between easy access and fixed rates. With a portfolio ISA, it lets you open several cash ISAs from a provider. And for savers with a H2B ISA who could contribute just up to £2,400 a year and were prevented from opening another cash ISA, the portfolio ISA gets round this problem.
According to Anna Bowes, co-founder of Savings Champion, the portfolio ISA is also valuable if you deposit less than the full allowance into a cash ISA, which then closes and does not allow any further subscriptions.
Bowes says: “This is a common situation with fixed rate cash ISAs. If the provider offers the portfolio ISA feature and you want to use more of your ISA allowance at a later date within the same tax year, you could open another cash ISA with them, without falling foul of the ISA rules.”
However, she adds: “It is important to note that the majority of savings providers will NOT allow this, so check carefully before proceeding if you intend to make use of this feature.”
What is a Flexible ISA?
Now, we know there’s a £20,000 annual allowance but with flexible ISAs, they allow you to take your cash out and then put it back in during the same tax year without reducing your current year’s allowance.
As an example: Against the £20,000 annual allowance backdrop you put £10,000 into an ISA during the 2022/23 tax year. You then take out £3,000.
- With a flexible ISA, you would be allowed to put £13,000 back in
- With a non-flexible ISA, you would only be allowed to put £10,000 back in.
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