An Individual Savings Account (ISA) is a tax-efficient account available to residents of the United Kingdom. The main perk of an ISA is that any interest, dividends or capital gains you earn within the account are exempt from income tax and capital gains tax (CGT). This means that the money you make from your investments stays ‘in your pocket’, helping it grow faster over time.
Types of ISAs:
There are several types of ISAs, each designed for specific savings goals and risk tolerances:
Cash ISA: This is similar to a regular savings account, where you deposit cash, and it earns interest over time. It’s a low-risk option ideal for short-term savings goals
Stocks and Shares ISA: If you’re willing to invest with a long term mindset, a Stocks and Shares ISA allows you to invest in stocks, bonds, and other financial instruments. Over the long term, this can offer better returns than a Cash ISA
Lifetime ISA (LISA): Aimed at helping you save for your first home or retirement, the Lifetime ISA provides a government bonus on your contributions. You must be between the ages of 18 and 39 to open a Lifetime ISA. There are some restrictions on withdrawals, so it’s essential to understand the terms
Junior ISA (JISA): If you’re under 18, a Junior ISA is designed for you. Parents or guardians can open one on your behalf, and it can be converted into an adult ISA when you turn 18
A simple breakdown of how ISAs work:
Choose your ISA type: Determine your savings goal and risk tolerance. For short-term goals or risk-averse investors, a Cash ISA might be best. If you’re looking to grow your wealth over the long term, consider talking to us about a Stocks and Shares ISA
Open an ISA account: You can open an ISA account through banks, building societies, investment platforms (if you use a financial adviser), or even online. It’s a straightforward process, requiring some personal information
Contribute: You can make deposits into your ISA account of up to £20,000 each tax year. Keep in mind that Junior ISAs have a lower limit of £9,000 each tax year. These are separate allowances, so depositing £9,000 into your child’s JISA does not count towards your own ISA allowance of £20,000.
You can contribute up to £4,000 per tax year into a Lifetime ISA, which will use up some of your ISA annual allowance. This means that you could contribute a further £16,000 to another adult ISA. The 25% bonus that you receive from the Government on your Lifetime ISA contributions do not use up your ISA annual allowance, meaning that you could have £21,000 added to your ISAs in this way each tax year (£4,000 to your Lifetime ISA + £1,000 Government bonus + £16,000 contribution to other adult ISA).
If you have a child who is 16 or 17 years old, they are entitled to both a Junior ISA and an adult ISA, meaning that they are also entitled to BOTH of the annual allowances that come with them. This means that the amount that can be saved into ISAs on behalf of these teenagers can increase from £9,000 per year to £29,000 per year. Note that the adult ISA during this transition period must be a cash ISA. Once they turn 18 years old, however, their annual allowance will revert back to the standard £20,000 per tax year – so there are only two years in which to take advantage.
Invest: If you opt for a Stocks and Shares ISA, you can start investing your money in a diversified portfolio of assets. Remember, investing carries risks, and it’s crucial to do your research or seek advice
Earn Tax-Efficient Returns: Any interest, dividends, or capital gains you earn within your ISA account remain exempt from CGT and income tax. This is a significant advantage that can help your wealth grow faster. You might easily fall into the trap of thinking that ISAs are tax-free, but that isn’t the case. ISAs are subject to inheritance tax (IHT)
Monitor and Manage: Keep an eye on your ISA’s performance and ensure you stay on track with your savings goals (or use a financial adviser to do this for you). As you get older, your priorities may change. People often shift in their approach towards certain things for a variety of reasons. This could manifest itself as a change in attitude to investment risk, for example; or taking a decision which requires capital such as purchasing a property.
Start Early: The earlier you start saving or investing, the more time your money has to grow due to the historical long-term nature of markets.
Government Bonuses: If you opt for a Lifetime ISA, you can benefit from government contributions. You can deposit up to a maximum of £4,000 into a LISA each tax year and the government will contribute 25% of what you deposit. You can do this each year until you reach the age of 50. The funds within a Lifetime ISA can only be accessed without penalty for the purchase of a first home (maximum value of £450,000) or once the account holder has passed 60 years of age. Should you wish to dip into this ISA for any other reason, you will be charged 25% on the withdrawal – and you don’t just lose the amount of bonus you receive:
£4,000 contribution + £1,000 bonus = £5,000
£5,000 withdrawal – £1,250 (25% penalty) = £3,750
Result = a loss of £250 (6.25% loss on the original £4,000 contribution)
Understanding ISAs is an important step towards securing your financial future. Whether you’re saving for a car, a house, or your dream holiday, ISAs offer a tax-efficient way to grow your money over time. Remember to research your options, set clear savings goals, and consider seeking financial advice if you’re unsure about your investment choices. With the right approach and discipline, you can use ISAs to build a solid foundation for a prosperous financial future.
HMRC have published their data about ISAs to the end of the 2018/19 tax year. Their data is reliable or should be because you will recall that each ISA requires your unique National Insurance number. As a result, it is possible to provide accurate data about income, age, gender, and employment.
The deeply disturbing news is that the vast bulk of ISAs are cash ISAs. Cash ISAs are glorified deposit accounts, cash is not a sensible long-term investment strategy, it is a perfect short-term spending strategy. As cash rates have declined from not very much to virtually nothing over the last 20 years, Cash ISAs have basically failed to keep pace with inflation.
“BUT CASH ISAs ARE LOW RISK”
“But Cash ISAs are low risk” you cry, well… what you really mean is that the value doesn’t go up and down (volatility) your assertion would be right, but when you factor inflation into the actual real world, then Cash ISAs are pretty much basically always guaranteed to go down. The risk you run is one of running out of money and the power of your pound shrinks.
There may of course be good reasons for holding Cash ISAs, but based on income range, people over £30,000 generally have more stocks and shares ISAs than Cash ISAs – though its still a fairly close-run thing.
“BUT AT LEAST CASH ISAs ARE TAX FREE”
Cash ISAs are tax free, that is certainly true. What that means is that the interest paid to you on your deposit is tax free. All good… well, it was. Since 6 April 2016 there has been a personal savings allowance. Basic Rate (20%) taxpayers are able to earn interest of £1,000 without it being taxed. Higher Rate taxpayers have a £500 allowance and Additional Rate – well, of course we know that it is politically expedient to be seen to punish anyone earning £150,000 or more, so no tax-free savings for you!
WHY LOCK INTO A DEPRECIATING ASSET?
Taking a basic rate taxpayer with interest rates at something like 1.5% at best, then you would need more than £66,000 in your cash ISA before any tax would be applied to the interest. At 1% it would require £100,000. Higher rate taxpayers simply halve the numbers. As for the tax that would be applied on interest above that – well no more than a round of drinks for most people.
A quick trawl of Cash ISA rates today (30/06/2020) and the very best rate I can find is 1.25% if you want to lock your cash up for 7 years… why anyone would do this is beyond me. Then there is the aggravation of regularly looking for a better rate and the hassle of moving your really rather duff Cash ISA into a different one. Life is too short for this nonsense isn’t it?
Similarly, junior ISAs – why bother holding cash for a child for 18 years and missing out on investment growth over nearly 2 decades. It is madness. Investors and savers really must understand what risk really means.
The value of ISAs to the end of the data was £584billion, of which cash ISAs account for 46% yet make up 76% of all ISAs. The chart below (from the HMRC bulletin – so labelled Chart 4) shows the fluctuating but growing value of shares in ISAs. Remember all are being added to each tax year, but the vast majority of the money each year goes into Cash ISAs.
CONFESSIONS OF A CASH ADDICT
OK – so you have some cash ISAs. I am not saying you shouldn’t have them, but only do so if you intend to spend the money fairly soon (within 3-5 years tops). Otherwise you are missing out on a lot of growth and the ability to keep the power of your £ working for you. If you would like a review, do some of the legwork, compile a list of your Cash ISAs, the balances, the Banks or Building Societies that they are with and the current rate of interest you earn. If there is a fixed rate, confirm when that ends. Then send me the information.
You can read more articles about Pensions, Wealth Management, Retirement, Investments, Financial Planning and Estate Planning on my blog which gets updated every week. If you would like to talk to me about your personal wealth planning and how we can make you stay wealthier for longer then please get in touch by calling 08000 736 273 or email firstname.lastname@example.org
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