Guide to Individual Savings Accounts (ISAs) and how they could help with your end of year tax planning
When it comes to saving and investing your money, one of the simplest and most common options in the UK is an Individual Savings Account (ISA). But what exactly is an ISA, and how can it help you save money without paying any tax?
In this blog, Castlefield adviser Olivia Bowen explores some of the different types of ISAs available, who they’re suitable for, and how you can use them for your end of tax year planning.
What is an ISA?
An Individual Savings Account, or ISA, is a special type of account that lets you save or invest money in a tax-efficient way. Any money paid into such accounts can grow tax-free and doesn’t have to be recorded on a tax return. You don’t pay any tax when you withdraw money from these accounts either.
There are many different types of ISA available, including cash ISAs, stocks and shares ISAs, Lifetime ISAs, Innovative Finance ISAs, Help to Buy ISAs and Junior ISAs - so you should consider what your objectives are for that pot of money and choose accordingly when considering which to take out. It’s also worth being aware of your tax-free allowance and how you can utilise different ISAs to maximise this.
Tax-free allowance
Each tax year (6th April to 5th April), the government gives everyone in the UK aged 18 and over a tax-free allowance that you can put into ISAs. This amount is known as your ISA allowance. For the current tax year the ISA allowance is £20,000.
If you don’t use your whole allowance in a tax year it doesn’t roll over to the next year.
Types of ISAs
There are several types of ISAs to choose from, depending on your circumstances and savings goals.
Cash ISAs:
What is it? A Cash ISA is like a regular savings account, but with the added benefit of being tax-free.
Who is it for? This is ideal if you want a safe place to store your money and earn some interest. However, keep in mind that Cash ISA interest rates are quite low and may not beat inflation, meaning the value of your savings might not grow as fast as with other types of ISAs.
How to use it for tax year planning? If you want quick access to your money and prefer low risk, a Cash ISA could be a good option for your savings.
Stocks and Shares ISAs:
What is it? A Stocks and Shares ISA allows you to invest in stocks, shares, or other investments, with the potential for higher returns than a Cash ISA.
Who is it for? This type of ISA is great if you’re comfortable taking a little more risk in exchange for the possibility of better long-term growth. It's recommended to leave the money in for at least five years to ride out any market ups and downs.
How to use it for tax year planning? If you’re thinking about growing your wealth over time and can afford to take some investment risk, this could be a good way to use your £20,000 allowance.
Lifetime ISAs (LISAs):
What is it? A Lifetime ISA helps you save for your first home or retirement. Lifetime ISAs are the only ISAs where you get an actual bonus from the government to top up your own savings and they grow tax free in the same way as other ISAs. You can deposit up to £4,000 each year, and the government will add a 25% bonus on top of what you contribute (up to £1,000 a year).
Who is it for? This is perfect for first-time home buyers or anyone saving for retirement. However, there are some rules about when and how you can use the money, so make sure you understand them. You can open an account any time from age 18 to 40. You have to stop paying in by the age of 50. It can be a cash or investment proposition.
How to use it for tax year planning? If you're under 40 and thinking of buying a home, or saving for retirement, the Lifetime ISA is a great way to get a bonus from the government while saving. The maximum you can pay in is £4,000 a year, and then you get a bonus from the government of 25%. So if you put the full £4,000 in, you get £1,000 from the government. The £4,000 counts towards the £20,000 annual limit, so you can only pay in £16,000 into your other ISAs. The money must be used for very specific purposes - either buying your first home or spending for your retirement from age 60. You can take it out early or for other purposes only if you are terminally ill, otherwise you will suffer a 25% charge on the withdrawal.
The property must cost £450,000 or less, you must be buying with a mortgage and you must buy the property at least 12 months after opening the Lifetime ISA. In addition, you have to use a conveyancer and the LISA funds are paid to the conveyancer - this is to ensure that people don't use the money for other purposes.
Junior ISAs:
What is it? A Junior ISA is a tax-free savings account for children under 18. The money belongs to the child, and they can start managing the account when they turn 16.
Who is it for? If you’re saving for your child’s future, this is a great way to grow their savings without paying tax. It’s important to remember that you can't hold a Child Trust Fund as well as a Junior ISA. The annual limit for a Junior ISA is £9,000 and the individual will have control at age 16 (but can't withdraw money until they are 18). The money belongs to them - not to the parents or grandparents or whoever has paid the money in. So that's worth remembering. For most people, In the year in which they're 18, they should be able to not only pay the £9,000 in when they're 17, but also pay £20,000 into an adult ISA once they're 18. So for that year alone, they could benefit from placing £29,000 in a tax free account, if it’s affordable, of course.
How to use it for tax year planning? This is a good option for long-term savings for your child, as they won’t be able to access the money until they’re 18. But equally you may not want to build up large sums in such accounts, as you can’t legally control when they access the money.
Innovative Finance ISAs:
What is it? This is a newer type of ISA and comes with higher risk. These tend to be for niche investments such as peer-to-peer loans, ‘crowdfunding debentures’ - investing in a business by buying its debt – or funds where the notice or redemption period means they cannot be held in a stocks and shares ISA.
Who is it for? If you’re comfortable with higher-risk investments, this could be a way to earn potentially higher returns. However, whilst they can have low minimums, they should be considered high risk so you should only invest what you can afford to lose. Some of our clients invest in these direct, in order to access renewable energy projects for example, but we don't recommend people invest in them unless they can afford to lose that capital.
How to use it for tax year planning? If you’re willing to take on more risk and want to diversify your investments, an Innovative Finance ISA could be a good choice.
Flexibility
Most modern adult ISAs are Flexible, which means that you can take money in and out within the tax year as long as you don't pay in more than £20,000 overall. It used to be that if you put £20,000 s in say, and if you needed £5,000 out in the same tax year, you couldn't put it back in again. So you'd end up with £15,000 s in your ISA. However, now if you put £20,000 in and then you need £5,000 out, but later you get a windfall and you can afford to put the £5,000 back in within the same tax year, you can do that. So it's worth checking that whatever ISA you take out is a Flexible ISA if you think that will be useful.
It's also possible to open ISAs with more than one provider, pay money in, empty them, change your mind, and set one up with a new provider - as long as you don't reach the £20,000 overall for the tax year.
Inherited ISAs
Another development within the world of ISAs that not everyone may be aware of is the Additional Permitted Subscription (APS) which is the natty title for inherited ISAs. This means that if you are married or in a civil partnership when your spouse or partner dies, you can inherit the tax-free status of their ISAs. So whether they are held in investments or cash, as long as that money is coming to you anyway, you won't lose the ISA wrapper that sits around them. From an admin perspective, the grant of probate has to be issued and the ISA provider(s) will need to see a death certificate. Then the surviving spouse or partner will fill in an APS form and then the provider will effectively nominate them as being the owner on the account. Then of course they can do what they wish with the money, and tax will not be an issue. Of course Inheritance Tax is not an issue between spouses or civil partners. If you are not married or in a civil partnership, you will not be able to benefit from the Additional Permitted Subscription rules.
How to make the most of your ISA before the end of the tax year
As the end of the tax year approaches, now is the time to make sure you're using your ISA allowance wisely. Here are a few helpful tips to remember:
- Utilise your allowance: You can save or invest up to £20,000 in an ISA each tax year. Don’t let it go to waste – use it or lose it!
- Use Flexible ISAs: Many ISAs are now "Flexible", which means you can take money out and put it back in without losing your tax-free allowance. Check with your provider to make sure your ISA is Flexible if you think you might need to withdraw money.
- Consider your long-term goals: If you're saving for something big like a house or retirement, an ISA like a Lifetime ISA can help you reach your goal faster by giving you a government bonus.
Written by Olivia Bowen
Sources
https://www.gov.uk/individual-savings-accounts
https://www.nutmeg.com/isas/what-is-an-isa
https://www.gov.uk/individual-savings-accounts/how-isas-work