Your ISA refresher on the basics

1. ISAs save a number of different taxes.
2. They save an awful lot of it.
3. They come in different guises.
4. They suit different people.
5. There are limits on what you can put in.
6. There are rules around transfers.
7. There are rules that kick in after you die.

Sarah Coles, head of personal finance, Hargreaves Lansdown:

1. ISAs save a number of different taxes

“If you don’t wrap savings and investments in an ISA, there are different kinds of tax due on different things. When you earn more than the personal savings allowance in interest on a savings account or peer-to-peer investment, you’ll pay income tax on the rest. The allowance is currently £1,000 for basic rate taxpayers and £500 for higher rate taxpayers – additional rate taxpayers don’t get an allowance.

When you earn more than the dividend allowance on investments outside an ISA, you’ll pay dividend tax on the remainder, and when you earn over the capital gains tax allowance (CGT) in profits on investments, you’ll pay CGT on the excess. The ISA avoids both.

Savings and investments for children are taxed as belonging to the child, so there’s usually no tax to pay. There’s a major exception to this though – if the parents are putting the money in, then if the child makes interest or dividends of over £100, it’s taxed as belonging to the parents. So if they’re over their personal savings allowance or dividend allowance, they’ll pay tax on it. A Junior ISA will protect them from this tax charge.

2. They save an awful lot of it

ISAs are set to save us an estimated £9.4 billion in income tax and capital gains tax this tax year. This has shot up by more than a fifth (22%) in the past year – up from £7.7 billion, thanks to a perfect storm driving potential tax bills up. This includes everything from cuts in the capital gains tax and dividend tax allowances to higher capital gains tax rates on stocks and shares, frozen tax thresholds boosting the level of each tax, positive stock market growth and robust interest rates.

3. They come in different guises

Cash ISA – this is essentially a savings account inside an ISA wrapper – so you don’t ever have to pay tax on interest. You can get a cash ISA from the age of 16.

Stocks and shares ISA – you can hold a range of funds and shares on an investment platform within a single ISA wrapper. This means you’ll never pay income tax or capital gains tax on bond investments, or dividend tax or capital gains tax on stock market investments. There’s no tax to pay when you buy and sell within the ISA or when you withdraw money. You can get a stocks and shares ISA from the age of 18.

Innovative finance ISA – you can wrap peer-to-peer loans in an ISA, and pay no tax on returns. These are very different to savings accounts, because they’re investments that involve more risk. The target rate you see is not guaranteed. They tend to be a niche product.

Junior ISA – this is for children aged 0-18. Any money you put in is tied up until the age of 18, at which point it belongs entirely to the child. In the interim, it is managed by a parent or guardian, who is the main contact for the account. Anyone can pay in, but only the main contact can invest the money. You can get a cash JISA or a stocks and shares JISA.

Lifetime ISA – these come as either cash LISAs or stocks and shares LISAs. If you’re aged 18-39 you can open a LISA and the government will top up your contributions – up to £4,000 a year – by 25%. You can use it to buy your first home – worth up to £450,000 (although you must hold the account for at least a year before you do this). You can also withdraw once you are 60. If you withdraw money for any other reason, you will pay a penalty.

Help to Buy ISA – this is closed to new entrants, but if you still have one, you can continue paying into it until November 2029 and claim a bonus until November 2030. It’s a cash ISA, designed to help first time buyers save for a deposit for any property worth up to £250,000 – or £450,000 in London. When you buy a property, the government adds a 25% bonus. If you withdraw the cash for any other reason, there’s no bonus.

4. Different people can get different things from them

JISA

For a child, it’s a nest egg and an opportunity to build an understanding of investments. For a parent, it’s a chance to help their offspring make a start in adult life. For a grandparent, it’s also an opportunity to make a gift during their lifetime for inheritance tax purposes but tie the money up until the child is 18.

LISA

For a first-time buyer it’s a helping hand onto the property ladder. For someone who is self-employed and pays basic rate tax, it’s more generous than a pension for the first £4,000 put aside each year. For a basic rate taxpayer who has maxed out employer matching in their workplace pension, it’s a sensible home for the next £4,000 of retirement savings. For someone earning enough to fall foul of the tapered annual allowance for pension savings, it’s an alternative home for more retirement investments. It may also make sense to have aLISA alongside a pension, because you can save tax when you draw an income. You can, for example, take an income up to the higher rate threshold from your pension, and then top it up with income from your LISA – which is tax-free. 

Stocks & Shares ISA

For someone investing for the first time, it’s a straightforward way to get started without having to think about tax. For those with larger portfolios, assets outside an ISA start to attract considerable tax, so an ISA protects them. For someone planning for retirement, who doesn’t qualify for a LISA or wants to put more than £4,000 a year away, it makes sense to have an ISA alongside a pension, so you can balance income in retirement, to ensure it’s tax efficient.

5. There are limits on what you can put in

The tax year begins on 6 April, and ends the following 5 April. Each tax year, you have an overall ISA allowance. This year it’s £20,000, and you can divide it between a cash ISA, stocks and shares ISA, Innovative Finance ISA, Lifetime ISA, and Help to Buy ISA. You pay into as many stocks and shares ISAs and cash ISAs as you want in each tax year after a change in the rules – as long as you stay within the overall £20,000 limit.

You can put money into both a LISA and a Help to Buy ISA, but it’s not recommended, because you can only get a bonus for a house purchase on one or the other.

Within the overall allowance, you can put up to £4,000 a year into a LISA, or £200 a month into a Help to Buy ISA.

In addition, children have a £9,000 JISA allowance.

6. There are rules around transfers

You can transfer between ISAs of the same type, and between different types of ISA – so cash to stocks and shares and vice versa. There some key things to note:

• It’s vital not to cash the ISA in and try to move the money, or it will come out of this year’s allowance. Instead, contact the provider you want to move to and ask them to make the transfer.
• Not all ISA providers accept transfers in.
• Innovative finance ISAs are more complicated. Any money sitting in cash with these ISAs can be transferred straight away, but you might not be able to transfer when money has been loaned out. Check the policies of your provider.
• If you want to transfer from a cash or stocks and shares ISA (or a Help to Buy ISA) to a Lifetime ISA, you can only transfer up to the annual limit – and the amount you transfer will come out of this year’s LISA allowance.

7. There are rules that kick in after you die

When you die, your ISA becomes a ‘continuing account of a deceased investor’ or a ‘continuing ISA’ for short. No more money can be paid into it at this point, but while your estate goes through probate, if it rises in value, this growth will be tax free.

Once probate is completed, if it is being passed to anyone other than your spouse it may be subject to inheritance tax (IHT). If it is passed to your spouse, however, not only is there no IHT, but they will get an additional ISA allowance – known as an additional permitted subscription. This is equal to the value of cash or investments passed on, or the value of the ISA on the date of death – whichever is higher – so they can wrap everything back up in an ISA without using up their annual allowance.”