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Individual Savings Accounts (ISAs)


What are ISAs?

Individual Savings Accounts (ISAs) provide a way of holding savings and certain investments so that there's no tax to pay on income or gains. The government offers these tax benefits as an incentive for us all to save and, to a lesser extent, invest in shares.

ISA Wrapper It's very important to appreciate that an ISA is not a savings account or investment in itself, but simply an advantageous tax 'wrapper' that surrounds savings accounts and/or investments. This means that when you buy an ISA, you really need to consider whether the savings account or investment(s) held within are right for you. Tax benefits are pointless if you end up owning an investment you didn't want!

If you were planning to save or invest anyway, then using an ISA could potentially provide worthwhile tax savings.


Who can buy an ISA?

You can buy a ISA provided you are:

  • Tax resident in the UK.
  • Aged 16 or over (for a cash ISA).
  • Aged 18 or over (for a shares ISA).

If you move abroad you can keep your existing ISA(s) but cannot contribute any more money.


What types of ISA are there?

There are two types of ISA:

Cash ISAShares ISA

Cash ISAs are just like a normal savings account, but with tax-free interest.

There's a wide range available, including easy access, notice and fixed rate accounts. The rates on offer tend to be more attractive than conventional savings accounts, but watch out for those that include an 'introductory bonus', as the rate will become less attractive in future.


How much can I invest in an ISA?

You can invest up to the annual allowance in an ISA each tax year (i.e. 6 April to the following 5 April). Of this, you can invest up to the full annual allowance in either a cash ISA, shares ISA or split between the two.

Overall Annual Allowance
£15,240

You may only use one ISA provider per component (i.e. one for cash and another for shares) each tax year.

If you accidently invest more than the allowance then the excess becomes void and the money returned to you with no tax benefit.


What are the ISA tax savings?

This is a key question, as saving tax is generally the only reason for using a ISA wrapper.

Changes to interest and dividend taxation outside of ISAs from 6 April 2016 means it's less likely most of us will save tax by using an ISA in the shorter term.

Basic rate taxpayers can earn up to £1,000 of interest each year without having to pay tax, while higher rate taxpayers can earn up to £500. And for all individuals there is now no further tax to pay on the first £5,000 of dividends received each year.

Add in that we all have annual capital gains tax allowances to shield gains from tax and the case for ISAs looks weaker than in the past.

However, ISA income does not count towards your overall income for tax purposes, unlike savings interest and dividends outside of ISAs. This could be a valuable benefit if your overall income is close to the higher or top rate thresholds.

On balance, provided you are not paying extra to hold savings or investments within an ISA then it still makes sense to use them where appropriate, since you may benefit from the tax benefits in future if not now.

The table below shows how much you might expect to save during the first year assumng you already exceeed your personal income tax, interest and dividend tax allowances mentioned above.

ISA Type Contribution Assumed Annual Income Annual Income Tax Saving
Non Taxpayer Basic Rate Taxpayer Higher Rate Taxpayer Top Rate Taxpayer
Cash ISA £15,240 1.40% None £42.67 £85.34 £96.01
Shares ISA (bonds) £15,240 5.00% None £152.40 £304.80 £342.90
Shares ISA (shares) £15,240 4.00% None £45.72 £198.12 £232.26
Figures based on current allowances and tax rates, these could change in future. Also assume no change to capital value.

Gains are tax free, which could prove a valuable benefit if you invest in a shares ISA long term. In the short term you're unlikely to benefit if you're not already using your annual capital gains allowance, currently £11,100.

ISA income does not need to be entered on your tax return.

Pensions provide a tax benefit on your contributions but your eventual pension income is taxable, whereas ISA tax benefits are on income and not your contributions.

Let's see how this works in practice:

ISA
Non Taxpayer Basic Rate Taxpayer Higher Rate Taxpayer
£1,000 Contribution £1,000 £1,000 £1,000
Value after 20 years at 6% annual growth £3,207 £3,207 £3,207
Annual income (assume 5%) - no tax £160 £160 £160
Pension
£1,000 Contribution with tax benefit £1,250 £1,250 £1,667
Value after 20 years at 6% annual growth £4,009 £4,009 £5,345
Annual income (assume 5%) £200 £200 £267
Annual income after tax £200 £160 £160
Figures based on current tax rates, these could change in future.

As you can, assuming tax rates don't change and you're in the same tax band when you take income as when you initially contributed, the tax benefits are the same (except for non-taxpayers, who benefit from the pension tax relief on their contribution).

However, this ignores the ability to take 25% of your pension fund as tax-free cash at retirement, giving pensions the slight upper hand.

In practice tax rates are likely to vary over time and you may well change tax bands between now and retirement, making an accurate comparison impractical. Both ISAs and pensions offer potentially valuable tax benefits and using a mix of both is sensible for many.


How quickly can I get my money back?

This depends on the underlying savings account or investment, but is normally straightforward and you could get your money within a few days.

However, when you take money out of a ISA you lose that part of your allowance forever unless its a current tax year contrubution that you pay back in the same year. It's usually better to take the money from other savings or investments you might own if practical.


Can I move my ISA?

Yes, if you're unhappy with your existing ISA you have several options:

Cash ISAShares ISA - SwitchShares ISA - Transfer

If the interest rate on your cash ISA looks uncompetitive then don't worry, it's very easy to transfer to a better rate with another bank or building society. You simply need to complete an ISA transfer form with the provider you wish to move to. They'll contact your current ISA provider and arrange for the monies to be transferred, which should be complete within a cxouple of weeks. Don't withdraw the money yourself, else you'll lose the tax benefits!

You also have the option to transfer your cash ISA into a shares ISA using a similar process to above.

When switching or transferring your ISA always check whether there's a penalty for doing so.


What happens when I die?

If you own an ISA(s) when you die then your spouse can inherit your ISA allowance allowing them to retain the tax benefits. Otherwise, the tax benefits will die with you and the underlying investments will be passed into your estate, either 'as is' or having been sold and turned into cash.


How can I buy an ISA?

If you wish to buy a cash ISA you'll invariably need to so from a bank, building society or National Savings. Once you've decided on the features you want (e.g. variable or fixed rate) it's a case of shopping around for a good deal.

If you're looking for a shares ISA you've several options:

Fund ManagerFund PlatformFinancial AdviserDiscount Broker

Buying your ISA directly from a fund manager is normally the worst of all routes. Although the ISA wrapper will probably be free, you may pay an initial charge and relatively high annual charges with no advice or guidance.

There's normally no benefit in taking this route, so avoid.


What are PEPs and TESSAs?

Personal Equity Plans (PEPs) and Tax Exempt Special Savings Accounts (TESSAs) were the forerunners to shares ISAs and cash ISAs respectively.

To find out more about TESSAs, visit the cash ISA page in the savings section here.

PEPs were introduced by the Conservative government in 1987 and ran until April 1999, when the Labour government replaced them with ISAs (although existing PEPs could remain invested). PEPs comprised two allowances, 'general' and 'single company'. The general allowance was very similar to the current stocks & shares ISA while the single company allowance restricted investment to the shares of just one company.

On 6 April 2008 PEPs were merged with ISAs, meaning any PEPs you did have now simply form part of your ISA portfolio.

Historical PEP, ISA & ISA Allowances
Year(s) General PEP Single Company
PEP
ISA
1987 £2,400 - -
1988 £3,000 - -
1989* £3,000 - -
1989/90* £4,800 - -
1990/91 £6,000 - -
1991/92 - 1998/99 £6,000 £3,000 -
1999/00 - 2007/08 - - £7,000
2008/09 - - £7,200
2009/10 - - £7,200
2010/11 - - £10,200
2011/12 - - £10,680
2012/13 - - £11,280
2013/14 - - £11,880
2014/15 - - £15,000
2015/16 - 2016/17 - - £15,240
* PEP allowance moved from calendar year to tax year, allowing some investors to benefit from a 'double' allowance.

Jargon

Here's some of the more common ISA jargon you might come across:

JargonMeaning
Cash ISAAnnual allowance that offers long term tax-free interest on your savings.
ISAIndividual Savings Account. An annual allowance that offers long term tax benefits on savings and investments.
Maxi ISAA type of ISA most commonly used for investing in shares. Scrapped in April 2008 in favour of simpler rules.
Mini ISAA type of ISA most commonly used for cash savings accounts. Scrapped in April 2008 in favour of simpler rules.
PEPPersonal equity plan, a forerunner to stocks & shares ISAs.
Stocks & Shares ISAAnnual allowance that offers long term tax-free growth and interest on investments, plus no further tax on dividends.