What is an individual savings account (ISA)?
An ISA is a type of tax wrapper which increases the returns on your savings and investments by protecting them from taxation. An ISA itself is not an investment, but a means through which you can save or invest your money. ISAs are a popular alternative to pensions for providing an income during retirement.
Tax protection with ISAs:
- No capital gains tax – beneficial if you exceed the annual £11,700 capital gains tax allowance
- No tax on dividends
- No income tax on bonds
You do not however receive tax relief on the money you contribute into an ISA.
Everyone over the age of 18 can save up to £20,000 into an ISA each year. This is known as your ISA allowance. Under 18s with junior ISAs have a lower annual allowance. If you do not use up all of your allowance one year, this is not carried over to the next year.
There are multiple types of individual savings account:
You do not have to have just one type of ISA. It is possible to save into multiple types of ISA and transfer money between them.
These ISAs are similar to normal savings accounts, however the interest is tax free. Cash ISAs are low risk as your money cannot fall in absolute value, however the returns are usually much lower compared to stocks and shares ISA.
Cash ISAs are particularly vulnerable to inflation. Currently, there are no cash ISAs which offer interest rates higher than inflation. Therefore, the real value of a cash ISA will fall – it will have less purchasing power each year.
Stocks and shares ISA
These ISAs allow you to invest your allowance in shares, funds, gilts and corporate bonds. Stocks and shares ISAs are more risky as there is a chance that it may fall in value if your investments perform badly, however if things go well, returns can be far greater than cash ISAs.
If you are under the age of 18, you can save into a junior ISA. The annual ISA allowance is £4,260. Once you turn 18, the money is transferred into an adult ISA.
Lifetime ISAs can be used to save for your first home, or for later life. They can be opened by anyone aged 18 to 40.
Until the age of 50, you can put up to £4,000 per year into a lifetime ISA. This counts towards your £20,000 annual ISA allowance.
The Government will add 25% to the value of your savings, up to a maximum of £1,000.
Like other ISAs, you can hold cash, or invest the money.
When you withdraw money from a lifetime ISA, a 25% charge will apply unless you are buying your first home under £450,000, aged 60+, or terminally ill with less than 12 months to live.
When can I withdraw my money from an ISA?
One of the advantages of an individual savings account over a pension is that you can take money out whenever you want. If however you do take out some money, it does not restore any of your ISA allowance for that year. For example if you have already invested £20,000 this year and you take some money out, you cannot save any more into that ISA as you have used up your allowance. You would have to wait until the following tax year to start saving again.
There are some cash ISAs which are known as flexible ISAs. The rule described above does not apply to cash ISAs – you can take money out and return it in the same tax year, without it affecting your allowance.
If you have used up your ISA allowance but still wish to invest
If you have used up your annual ISA allowance, but still wish to invest, then a general investment account (GIA) is ideal. GIAs do not offer tax protection, but there is no limit to the amount of money you can invest each year.