ISAs (Individual Savings Accounts) are a ‘must-have’ for nearly everyone, whether you are making short-term savings or long-term investments, thanks to their tax efficiency and flexibility. There are different types of ISAs to choose from depending on your savings and investment objectives. You have to be a UK resident to open an ISA.
Here are the different types of ISAs – bear in mind that you may be eligible for more than one type:
Banks and building societies are the main providers of cash ISA accounts. They are much like ordinary savings accounts but with the added advantage that the interest is tax-free. They can accept deposits from as little as £1 up to the maximum ISA subscription which is £20,000 for 2018/10 and 2019/20). You can split your ISA allowance between a cash ISA and a stocks and shares ISA. You are only allowed one cash ISA per tax year, but each year you can open a new cash ISAs with a different provider.
Most cash ISAs pay variable interest rates, often with temporary introductory bonuses to start with. After the bonus period ends, it is important to check what rate you are getting, and you may need to transfer to a better deal. There are also fixed rate ISA accounts which typically run for between one and five years. Early withdrawals from these accounts normally incur a penalty.
These are generally cash ISAs which allow you to take money out at any time and return it in the same tax year (tax years run from 6 April one year to 5 April the following year). In the past, money withdrawn could not be paid back in unless you had not yet reached the maximum investment. But not all cash ISAs are flexible and it is up to the ISA provider.
Cash in a stocks and shares ISA can also be flexible, and so can Innovative Finance ISAs. Also, you are allowed to withdraw the current year’s cash from one type and replace it in another type. So you can, for example, withdraw money from a cash ISA, and pay it back into an Innovative Finance ISA.
Help to Buy ISAs
Aimed at first-time buyers trying to save a deposit, these ISAs enable you to earn a potential 25% tax-free bonus from the government when you buy a property. They allow you to save up to £1,200 in your first month, then up to £200 a month after that in a cash account. The bonus is added to your savings and interest at the point you use the money towards the property. The minimum amount of savings required to qualify for a bonus is £1,600. The maximum savings that will qualify are £12,000. The Help to Buy bonus is only available if you are buying a home worth up to £250,000, or £450,000 in London.
You are only allowed to have one Help to Buy ISA. but you can transfer it between providers to get a better interest rate. In theory, you cannot contribute to both a Help to Buy ISA and a cash ISA in the same tax year but some providers offer a combined package of the two. New accounts cannot be opened after 2019 as they are being replaced by Lifetime ISAs.
Innovative Finance ISAs
These accounts, first introduced in April 2016, allow you to lend money directly via an ISA to individual borrowers or companies and receive interest on your loans tax-free. These loans are normally arranged through peer-to-peer lending platforms, which take a small fee. Up to £20,000 can be lent via these ISAs in 2018/19 and 2019/20. Rates of interest are higher than on normal savings accounts because of the greater risk involved. Your interest and capital aren’t guaranteed. The loans are not covered by the Government-backed Financial Services Compensation Scheme which protects the first £75,000 of savings with a bank or building society.
These ISAs are for adults who want to make tax-free savings on behalf of children under the age of 18. up to £9,000 (from 6th April 2020) can be saving or invested in Junior ISAs each tax year. They can hold cash or stocks and shares, or a combination of both. Junior cash ISAs are available from many banks and building societies. Junior stocks and shares ISAs are offered by some fund groups and investment trust managers. If there is at least ten years until the money is needed, it is worth considering Junior stocks and shares ISA as stock markets have historically produced better returns than cash accounts over the long term.
However, bear in mind that as most children do not pay income tax, the tax efficiencies of Junior ISAs are of limited use. At the same time, any money placed in a Junior ISA becomes the child’s and is locked away until the child reaches 18. Then it is theirs to either spend on whatever they like or to roll into an adult ISA. An ordinary children’s cash savings account or investment trust savings scheme for children may be considered a more flexible alternative over which adults have greater control.
Lifetime ISAs (LISAs)
These ISAs were launched in April 2017. They are designed to help the under 40s save towards a first home deposit or their pension. You will be able to save up to £4,000 a year into a LISA either as a lump sum, regular savings or on an ad-hoc basis. Your contributions can be placed in cash savings or stocks and shares. The state will add a tax-free 25% annual bonus on top at the end of the year and then the bonus is paid monthly in the following tax year. It will be calculated on your contributions. Bonuses will be paid until you reach age 50. Based on current rules, the maximum bonus savers can earn is £32,000 if they were to save the full annual contribution from age 18 to age 50.
The money can be used either towards a first home worth under £450,000 or for retirement income after age 60. If it is withdrawn for any other purpose or earlier than age 60, the bonuses will be forfeited and a penalty applied. However, you can transfer your LISA to a different provider to get a more competitive deal.
Stocks & Shares ISAs
These are ISAs that can be invested in shares, investment funds, investment trusts, ETFs and bonds. They are open to adults aged 18 or older. The maximum stocks and shares ISA subscription is £20,000 for 2018/19 and 2019/20. This amount can also be split between a cash ISA and a stocks and shares ISA. Any capital gains generated by the investments in a stocks and shares ISA are tax-free and there is no further tax on any income or dividends. You can only have one Stocks and Shares ISA per tax year but if you invest through a platform you can hold a mixture of funds and other investments within a single year’s ISA.
Stocks and shares ISAs are worth considering for long-term investments as over the longer term they have historically produced higher returns than cash accounts. Another advantage of holding investments in an ISA is that they do not have to be declared on your tax return. Stocks and shares ISA can be opened with as little as £100 or sometimes less. Both lump sum and monthly savings stocks and shares ISAs are also available.
There are many reasons you may want to transfer your ISA such as to get a better deal or because your investment objectives have changed. Here are some points to bear in mind.
- There is no limit on the number of times ISAs can be transferred.
- You can transfer your money between cash and stocks and shares ISAs and vice versa.
- You can transfer your current year’s ISA subscriptions and/or all or part of the previous year’s subscriptions. However, if you are only transferring this year’s ISA you must transfer all that you have paid in this year.
- Always ask your new ISA provider to carry out the transfer for you. Don’t withdraw the money yourself otherwise you will lose the tax benefits.
- Not all ISA providers accept transfers.
In addition to your own ISA allowance, an Additional Permitted Subscription allowance (APS allowance) is available if your deceased spouse or civil partner was an ISA investor, providing death occurred on, or after, 3 December 2014. The APS is equivalent to the value of the ISAs held by the investor at the date of their death. Essentially, this means you can transfer their ISAs into your name without losing the tax benefits. You will normally have up to three years to complete this process.