An ISA lets you build up your savings and earn interest without paying any income tax. But there’s a limit to how much you can save with an ISA per year. Here’s everything you need to know about ISAs.
What is an ISA?
Put simply, an ISA – an individual savings account – is a savings account with tax-free returns. Every tax year you have an ISA allowance: a certain amount of money, decided by the government, that you can put into your ISAs. Any interest you gain from your ISAs will never be taxed.
This tax year, from 6th April 2018 to 5th April 2019, the annual ISA allowance is £20,000. After the 5th of April you will have a brand new ISA allowance – and your previous allowance, if you didn’t put away the full £20,000, doesn’t roll over.
If you keep putting away a chunk of money every year, you could eventually generate a large amount of tax-free income from your ISAs.
How much tax do you save with an ISA?
Any interest that you generate from your ISAs is tax free, irrespective of your income tax bracket.
The new personal savings allowance (PSA) also allows some people on basic (20%) and higher (40% or 41% in Scotland) income tax brackets to earn some tax-free interest on savings not held in ISAs – in a conventional instant-access savings bank account, for example. The interest earned from ISAs is completely tax-free, though, for everyone, with no upper cap.
Who can open an ISA?
To open an ISA, you need to be 16 or older (or 18 for a stocks and shares ISA), be a resident in the UK, and have a national insurance number.
ISAs are only for individuals – you can’t have a shared ISA, or an ISA in joint names.
What types of ISA are there?
There are two main types of ISA: cash ISAs, and stocks and shares ISAs. You can split your annual ISA allowance between different types of ISA if you wish.
Cash ISAs are quite similar to savings bank accounts, but usually there will be stricter limitations on how and when you can withdraw funds. Most cash ISAs will offer you a fixed-term interest rate for between one and five years – but if you withdraw funds within that period you might be heavily penalised (for example, you could lose a whole year of interest). Cash ISAs usually offer quite a low interest rate – somewhere between 1% and 1.5% right now.
Stocks and shares ISAs
Stocks and shares ISAs, also known as investment ISAs, invest your money in the stock market. Your money is actively invested, so the return is directly linked to the success (or failure) of the investment. You could earn a lot more than a cash ISA, or you could lose it all.
Each investment ISA is different, but usually you can choose where your money is invested – or if you don’t know anything about the stock market, you can leave those decisions to the investment fund manager. Investment ISA providers will usually publish their performance from previous years, but past performance is not a predictor of future growth.
Unlike cash ISAs which are usually free, most investment ISAs will charge you a monthly or annual fee.
There are also a few specialised ISA products, including the Junior ISA, Help-to-Buy ISA, Lifetime ISA, and Innovative Finance ISA. Most of these are exactly what they sound like: a tax-free wrapper around a savings account with special rules dictating how much you can deposit and when you can withdraw.
The Lifetime ISA, for example, only lets you deposit £4,000 per year, and the only times you can withdraw money without being penalised are for your first home or when you retire.
How do you open an ISA?
Depending on the provider, you can open an ISA by going into a bank branch, by post, online, via a mobile app, or on the phone. There is usually a minimum initial deposit, from £1 up to a few thousand, or a recurring minimum monthly deposit.
The ISA provider will also need some personal details from you, including your full name, address, national insurance number, and a signature. You will need to read and sign the provider’s ISA declaration; be sure to read the document carefully as it may include any restrictions and penalties for withdrawing funds from your ISA.
How many ISAs can you have?
You can create one investment ISA, one cash ISA, and one innovative finance ISA per tax year. When the tax year resets in April, you can again open one of each type – so after a few years you could have many ISAs indeed!
No matter how many ISAs you open, though, your tax-free ISA allowance is limited to £20,000 per tax year. It’s also important to note that, even if you have multiple ISAs of the same type, you can only pay into one of them each tax year. If you have a few different ISAs, you might choose to pay into the one with the best interest rate, for example.
Can you withdraw money from an ISA and then put the money back later?
If your ISA is ‘flexible,’ then you can withdraw money and pay it back within the same tax year without nibbling away at your ISA allowance. You can also withdraw money that you deposited during previous tax years – and if you pay it back before the end of the current tax year, it won’t affect this year’s ISA allowance.
If you withdraw money from a non-flexible ISA, putting it back in will hit your ISA allowance as if it were fresh funds.
Similarly, if you move your ISA funds into a normal savings account, the money will lose its tax-free status and HMRC will tax you accordingly (taking into account your personal savings allowance where applicable).
Can you transfer an ISA to a new provider?
Yes, most ISA providers will allow you to transfer your ISA funds from another provider. You might choose to transfer an ISA if you’re offered a better interest rate, or you want to move your stocks and shares ISA to a different provider with different investment funds.
If you transfer an ISA properly you won’t damage your annual ISA allowance; it should transfer over cleanly. If you transfer your ISA manually though – by withdrawing all of your funds from an ISA and then paying it into a new ISA – then that will eat up your ISA allowance.
If you want to stay with the same ISA provider, but move your funds to a different product or type of ISA, most providers will let you do that.
What happens to your ISA if you die?
When you die, your civil partner or spouse can move your ISAs into their name. This is known as an additional permitted subscription allowance. In essence, the person inheriting your ISA gets an additional ISA allowance equal to the value of your ISAs.
Now read all about cash ISAs