The individual savings account (ISA) is an important tool when it comes to investing – a government orchestrated carrot designed to encourage the type of saving and investing behaviour that helps secure our financial futures. Just like a bank account, you open one and put money into it, but it has rules over what you can and cannot use the money for and, in some cases, how you are able to access it again.
ISAs are often referred to in the industry as a tax-wrappers, in the sense that, as long you follow the rules of the ISA you are sheltered from any tax on your income or on any growth of your capital. You don’t even need to tell the taxman about what you do in your ISA, which, if the dread of filing in tax returns makes your eyes water, you might find the relief washing over you like a cancellation from the in-laws.
How do ISAs work?
Where can I get one?
These types of accounts are offered by all sorts of financial institutions, including share dealing platforms, digital wealth managers, banks, buildings societies, and so forth.
Are there different types?
There are four types of ISAs: Cash, Stocks & Shares, Innovative, and Lifetime. (Junior ISAs are actually a fifth but they don’t count to your allowance so I will deal with those separately.)
Are there any restrictions on the accounts?
Yes in some cases in terms of what you can use the money for, when or how you can take it out, but also how much money you’re allowed to put in in a single a tax year, known as your contributions. Your TOTAL annual limit for April 20/21 is £20,000, unchanged from the previous year.
Can I have trillions of accounts?
Yes, sort of. Aside from the high probability there are many better things to do in life, you can open as many types of ISAs as you like in a single tax year, just not two of the same i.e. opening two cash ISAs with two different providers in the same year; and as long as your contributions across all accounts are not more than £20,000. So, in a single tax year, you would be allowed to put £10k into a Stocks & Shares ISA, £8k into a Cash ISA, and £2k into an Innovative ISA, with three different providers.
The different types of ISA
1. Cash ISA
Key Features:
Avoiding tax on the interest you receive in your savings accounts.
You can use your whole allowance of £20k.
How do they work:
A fixed-rate ISA pays a guaranteed interest rate over a period of time, but there may be penalties if you withdraw before your term is up.
There are also instant cash ISAs which enable easy access, but interest rates tend to be lower.
Things to think about:
Interest rates are terrible presently, having recently just got worse! Does this beat inflation? Likely not. It means you’re paying for an ISA to lose value over time.
Your first £1,000 in interest is tax free anyway – to earn more than this in interest requires you have a lot of cash. Is it worth it?
2. Stocks and Shares ISA
Key Features:
This is the key investing account – get one!
Avoid tax on any uplift you receive in the value of your investments (capital gains tax), or on any income such as dividends.
You can use your whole allowance of £20k.
How do they work:
Open an account and start investing across company shares, company bonds, trackers, funds, and investment trusts – basically, any investments listed on recognised stock exchanges around the world. In the UK, this includes the junior stock market – the Alternative Investment Market (AIM).
Things to think about:
These are serious tax benefits – use your allowance before doing anything else.
Remember you also have a capital gains allowance of £12,300 for 20/21, so you’re not totally restricted to investing tax-free in your ISA.
3. Lifetime ISA
Key Features:
Helping people onto the property ladder but also those saving for retirement.
£4000 limit, which the government tops up by 25%, so £1000 at the limit.
How do they work:
You can open one if you’re aged between 18 – 39, and can pay into it up to the day before your 50thbirthday.
You can invest in stocks & shares, and also cash.
If you buy a house it has to worth less than £450,000.
If you don’t buy a house then you’ll need to wait until retirement to use the money.
Things to think about:
Replaces, and is really an extension of, the Help to Buy ISA, adding in pension benefits. As your tax benefits are determined by what you pay in, rather than the value of your pot at the end like a SIPP (which is penalising you for your brilliant investment decisions), we think the benefits are better, albeit limited.
4. Innovative Finance ISA
Key Features:
These were launched to encourage new, innovative (well you’d hope so considering the name) forms of financing that don’t pass through official exchanges, in this case peer-to-peer loans, which are effectively company bonds offered directly to the man on the street like you and me.
How do they work:
No banks or middlemen, which is great for the companies but potentially riskier for the buyer, so you’re given a higher rate for you.
Things to think about:
Well, there’s no banks or middlemen, which means less vetting. Some commentators believe there’s unforeseen risks brewing, which are fair concerns, so treat with caution and don’t invest too much.
5. Junior ISA
Key Features:
Cash and investments for each child up to the age of 18, at which point it morphs into a Stock & Shares ISA for them to wantonly pillage.
How do they work:
£9000 per year limit for 20/21, up from £4,368.
Child takes control at 16, but can’t withdraw until 18.
Doesn’t count to your allowance: separate amount per individual child.
Things to think about:
Sizeable jump in the allowance this year points to a government that knows it has a problem with runaway big-ticket items like house purchases for the younger generations. As relatives can also pay in – this could help avoid a generation of desolate renters.
Tips to Investing
- Considering the tax benefits – a Stocks & Shares ISA is an absolute must when it comes to investing.
- Check the ISA account has the breadth of choice to enable you to invest how and where you want.
- Check how much you’re being charged – high fees erode gains more than you think!