Holly Thomas
Whether it’s saving for your retirement, children, a first home, or simply for a rainy day, ISAs (individual savings accounts) are a tax-efficient way to help you achieve your financial goals. We look at how they work in our ISA guide.
There are six types: cash ISAs, stocks and shares ISAs, junior ISAs, Lifetime ISAs, innovative finance and Help to Buy.
While ISAs are a great way to protect your money from the taxman – and some even come with free cash from the government to encourage you to save – there are a few rules to be aware of.
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ISA rules: How ISAs work
One of the main ISA rules is the annual allowance. You can currently save or invest a total of £20,000 across all your adult ISAs, each tax year. So, you could save £5,000 in a cash ISA and place a further £15,000 in a stocks and shares ISA. Note that this is a maximum threshold, so you could also choose to save just £2,000 in an ISA for the tax year.
Junior ISAs have a separate annual allowance, which is £9,000. You also need to be mindful of additional annual limits on Lifetime ISAs and Help to Buy ISAs.
Remember, ISA allowances are handed out on a “use it or lose it” basis – any unused allowances cannot roll over into the tax year. So, it's always a good time to gen up on how to make the most of your £20,000 allowance.
We explain how the limits work, and run through everything else you need to know about ISAs; from what sort of investments you can hold, to how to transfer an ISA.
How cash ISAs work
A cash ISA is essentially a savings account where you pay in money and earn interest on your savings. The key difference is that, unlike a conventional savings account, a cash ISA means the interest is tax-free, so regardless of how much you earn, you won’t pay a penny in tax.
There are several different cash ISAs to choose from:
- An easy-access ISA is a useful home for your emergency savings pot, as these allow you to withdraw money when you need it without incurring a penalty – although some may restrict the number of withdrawals so do check.
- Fixed-term ISAs pay an agreed interest rate over a set period of time, typically one to five years, much like a savings bond. They tend to offer higher rates than easy-access ISAs, but in exchange, you have to leave your money untouched.
- Flexible cash ISAs allow you to take money out and replace it during the same tax year, without that amount being deducted from your allowance. For example, you could pay in £20,000, then withdraw £5,000, and a flexible ISA would allow you to pay the £5,000 back in during the same tax year. Not all cash ISAs offer this “flexible” status, so check with the bank or building society, especially if you plan to use this account as an emergency savings pot where you might need to make withdrawals.
As previously noted, the total you can pay into adult ISAs, per tax year, is £20,000. So, you could contribute the maximum of £20,000 to a cash ISA. Or you could decide to split the total and contribute £10,000 to a cash ISA, £7,000 to a stocks and shares ISA, and £3,000 to a lifetime ISA.
It is possible to hold multiple ISA accounts within your £20,000 allowance. Before 6 April 2024, you could only hold one cash ISA and one stocks and shares ISA per tax year. Now, you can hold multiple ISA accounts, of the same type, within the same year.
In terms of transferring an ISA, you’re free to move a cash ISA to one that pays a better interest rate without affecting this year's allowance – as long as you complete the correct transfer forms.
For your money to retain the all-important tax-free status, contact the ISA provider you want to move to and complete the transfer form. If you withdraw the money without doing this, you will not be able to reinvest that part of your tax-free allowance again. If you want to move money you’ve invested in an ISA during the current year, you must transfer all of it.
Cash ISA transfers should take no longer than 15 working days, according to government rules. You’re also free to move to a different type of ISA, such as from cash to stocks and shares, or say, from innovative finance to cash.
How stocks and shares ISAs work
Stocks and shares ISAs, also known as investment ISAs, allow savers to invest in a broad range of assets. Any investment gains you make will not be subject to capital gains tax, income tax or dividend tax. The only tax you may have to pay is stamp duty when buying shares.
The best way to think of a stocks and shares ISA is an investment account with a tax wrapper around it. Like a general investment account, you can buy everything from shares to bonds to property in the form of real estate investment trusts (REITs), plus open-ended funds (Oeics) and exchange-traded funds (ETFs).
Some stocks and shares ISAs are ready-made portfolios (think MoneyBox, Wealthify and Nutmeg) while there are also lots of DIY versions (providers include Hargreaves Lansdown, AJ Bell, Charles Stanley Direct and many others), where you can pick your own funds, bonds and shares.
As with any investment account, ensure you check the fees charged by the ISA provider. There could be an annual fee for a stocks and shares ISA, fees to trade investments, and possibly an exit charge.
To move a stocks and shares ISA, ask your new provider for a transfer form. Transfers usually take longer than those for a cash ISA. The government says providers should complete them within 30 calendar days.
How Lifetime ISAs work
Lifetime ISAs are the most generous member of the ISA family, with a government bonus of up to £32,000 on offer. Launched in April 2017, they have the dual aim of helping those under 40 get onto the property ladder or save for retirement.
To open one, you must be aged between 18 and 39. You can contribute up to £4,000 each tax year until you’re 50. The money you pay in counts towards your £20,000 ISA limit. You can hold cash or stocks and shares in a lifetime ISA, or a combination of both.
The best bit about lifetime ISAs is you get free cash from the government with each deposit. You’ll get a juicy 25% bonus worth up to £1,000 every tax year, depending on your contribution. For example, if you pay £2,000 into your lifetime ISA in a tax year, you’ll receive a £500 top-up.
You can only access the money at 60 or over, or to buy your first property up to the value of £450,000.
While the government bonus is a great incentive to open a lifetime ISA, bear in mind that if you use it for anything other than your first house or for a pension, you’ll be hit with a 25% withdrawal charge, which means you could end up with less than you put in.
How Junior ISAs work
If you have children or grandchildren, you can save into a junior ISA for them.
These can be cash or the stocks and shares variety. The account has to be opened by a parent or guardian, but once it’s set up, anyone can add money to it up to £9,000 per tax year. As with adult ISAs, any investment gains or interest earned is totally tax-free.
The child cannot access the money until they are 18. As soon as they reach their 18th birthday, they can spend it – or save or invest it – as they choose. This means alongside the cash you deposit into their account, try and also deposit good financial habits into their brains by teaching them about money.
If your child has a child trust fund (CTF) – and those born before January 2011 will have one – consider moving it into a junior ISA. Simply request a transfer form from the junior ISA provider. Cash junior ISAs typically have higher interest rates than CTFs, while stocks and shares junior ISAs generally have lower fees than the CTF versions.
How Innovative Finance ISAs work
Innovative Finance ISAs (IF ISAs) were introduced in 2016 to allow people to invest some or all of their £20,000 annual allowance in peer-to-peer lending and enjoy tax-free returns.
This involves lending your money directly to businesses and individuals without a middleman, such as a bank, in return for interest. Providers include Triodos Bank and EasyMoney. Today, they remain a niche product. In December 2019, the FCA introduced rules that prevented new investors from putting more than 10% of their assets into the sector without independent advice, and, generally speaking, IF ISAs are now only available to “sophisticated” investors, high net-worth investors, or institutional investors.
These are considered the most risky ISA option. Because each ISA provider tends to specialise in a particular niche – small businesses, consumers or property developers, for example – and you can only contribute to a single IF ISA in any one tax year, it is difficult to diversify across different sectors.
How Help to Buy ISAs work
It’s no longer possible to open a Help to Buy ISA, as they have been replaced by Lifetime ISAs. However, if you already have one, you can continue paying into it until November 2029.
You can contribute up to £200 each month and the government will then top up your savings by 25% (up to £3,000) when you buy your first home. You can claim the bonus until November 2030. The home you buy must be priced at £250,000 or less (£450,000 or less in London), be the only property you own and where you intend to live.
Lifetime ISAs are more flexible as the property maximum is £450,000 for the whole of the UK, you can use it as a retirement nest egg if you don’t end up buying a home, plus the annual allowance is higher. So you may wish to consider transferring a help-to-buy ISA into a Lifetime ISA.
Are ISAs subject to inheritance tax?
ISA savings and investments do form part of an estate for inheritance tax (IHT) purposes. That said, married couples and civil partners are allowed to pass their estate to their spouse tax free when they die.
ISAs can also be passed on and retain their all-important tax-free status.
The additional permitted subscription (APS), also known as the inherited ISA allowance gives an additional allowance, allowing more tax-efficient savings to be made.
For example, if you have £100,000 in your ISAs. When you die, your husband, wife or civil partner will get a one-off £100,000 ISA allowance, in addition to his or her £20,000 allowance.
This allowance can be used by a spouse or civil partner, regardless of whether an ISA is left to them or not.
So even if you decide to leave the money in your ISAs to someone else in your family, your spouse is still entitled to the extra allowance to the value of the assets held in your ISAs.
If that £100,000 of ISA assets was left to a child, your spouse would still be entitled to an increased ISA allowance of £100,000 and use their own money to fund it.
If you've been contributing to a junior ISA for your child or grandchild, payments may be subject to inheritance tax if you leave an estate worth more than £325,000. However, rules surrounding 'gifting' will apply. You can give gifts of up to £3,000 each year, without incurring IHT. There’s another gift allowance that allows you to hand out £250 to a person each year. It can't be used on somebody you've already used an allowance on, however.
There will be no IHT to pay if the money was paid into the junior ISA seven or more years before your death.
Are ISAs worth it?
ISAs offer a tax-efficient way to save or invest money tax-efficiently, where you can reach it at any time.
Benefits include tax-free growth – there’s no tax on interest paid, capital gains tax on profits from investments or dividend taxes on income from investments.
You can also pass on the value of your ISA to a spouse or civil partner tax-efficiently.
Whether they are worth it for you depends on your individual circumstances. For example, you should only be building up savings and investments if you haven’t got any debts. If you have credit card balances and an overdraft to clear, you’re likely better off addressing these first.
Are ISA rules changing?
Tax rules and allowances can and do change over time so it’s important to maximise them while they are around.
Every now and then – usually in the run up to a Spring or Autumn Statement – rumours swirl about ISAs under threat.
The most recent whispers suggest chancellor Rachel Reeves might axe cash ISAs to encourage more people to invest. The government hasn’t commented on this so at the moment this is only speculation. If the government does decide to scrap or change cash ISAs, it would only likely apply to new contributions, not existing ones.
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