The year 1999 was an important one for financial measures. Many that were introduced then still exist today, including the national minimum wage, child tax credits and individual savings accounts (ISAs). ISAs are savings accounts designed to take the place of personal equity plans, bringing tax-efficiency, simplicity and flexibility. As we celebrate the ISA’s 21st birthday, it is clear that they have become a cornerstone of how we save and invest today.
Saving into an ISA
Every adult UK resident has an annual allowance each tax year, £20,000 in the 2020/21 tax year, that they can shelter in the tax-efficient ISA ‘wrapper’. This amount has risen generously since the original £7,000 allowance in 1999/00 and has far outstripped inflation. In the 2018/19 tax year, more than £67bn was subscribed to adult ISAs of various kinds1.
It is possible to split the allowance across different types of ISA, subject to some specific rules regarding lifetime ISAs. For example, you could save £10,000 into an investment (or ‘stocks and shares’) ISA and £10,000 into a cash ISA. However, it is important to note that you cannot invest in more than one ISA of the same kind during a tax year.
Part of the ISA’s success has been its relative simplicity, as well as the generous tax benefits.
You will not pay any tax on money saved into an ISA. The interest received in cash ISAs or dividends received in investment ISAs do not attract income tax, and any gains made on ISA investments will not be liable to capital gains tax. Additionally, ISAs do not need to be reported on self-assessment tax returns, making their administration incredibly simple.
Different types of ISA
The ISA landscape has expanded in recent years. Initially you could only save into a cash or stocks and shares ISA, which many people will be familiar with. Additional variants have been introduced in recent years and there are currently five different types of ISA available:
- Cash ISAs are the most popular type of ISA and are simply a tax-efficient version of a standard savings account. Despite interest rates being very low for many years now, those with large enough cash savings can still find themselves paying tax on interest where it exceeds their personal savings allowance (if they have one). In an ISA, however, interest received is tax-free. Like a savings account, cash ISAs can be instant access or tied in for a fixed term.
- Stocks and shares ISAs allow savers to invest in bonds, shares or collective funds. This enables an investor to target a long-term investment return greater than the current interest rates available from cash savings. The overall level of risk will depend on which investments are chosen. Selecting appropriate investments for your needs and objectives requires careful thought and research, and this is where seeking financial advice can help.
- Junior ISAs are designed for children and currently have a subscription amount of £9,000 in the 2020/21 tax year, just below half the adult allowance. Junior ISAs can hold either cash or stocks and shares. Once the child turns age 18, it converts into a normal adult ISA and becomes their legal property.
- Lifetime ISAs are available for those between the age of 18 and 40 and have the usual ISA tax benefits. In addition, a government bonus is granted on the funds when they are used for buying a first home or withdrawn after age 60. Subject to certain criteria being met (for example, you must be under the age of 50 when contributing), the Government pays an additional 25% on the amount invested up to a lower annual subscription allowance of £4,000 in the 2020/21 tax year. If the funds aren’t used for a qualifying purpose, however, investors face a penalty on withdrawal. The Lifetime ISAlimit of £4,000 counts towards your annual ISA limit. You can still use any remaining ISA allowance through another type of ISA. You can hold cash or stocks and shares in your Lifetime ISA or have a combination of both.
- Innovative finance ISAs are relatively new and can hold either cash or peer-to-peer loans, which could be made to businesses or for crowdfunding purposes. Holden & Partners do not provide advice regarding Innovative finance ISAs.
Where investments are held within the above (non-cash) ISAs, returns are not guaranteed, and the value can fall as well as rise. You may not get back what you invest.
The ISA legacy
Over the previous 21 years, ISAs have offered an increasingly generous way to save money in a tax-efficient manner and there are now estimated to be more than 1,000 ‘ISA millionaires’2.
Although new varieties that reflect economic trends have been introduced (noticeably ISAs designed to help younger people onto the property ladder), ISAs are still relatively simple with few of the complications associated with pensions. Contributions are not linked to your earnings which keeps things straightforward and, apart from Lifetime ISAs, there are currently no restrictions on when the money can be taken out.
At Holden & Partners, we believe that ISAs are a key part of financial planning.
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Please note that any thresholds, allowances, percentage rates and tax legislation stated may change in the future. The content of this communication is for your general information and use only; it is not intended to address your particular requirements. This communication should not be deemed to be, or constitute advice. You should not take any action without having spoken with your usual adviser.