ISAs – Individual Savings Accounts
An ISA is a tax-efficient ‘wrapper’ in which a UK resident can hold cash or certain other investments, including stocks and ETFs. Because gains from an ISA – including capital gains on an asset or dividend payments – are tax-exempt, they are a popular way for UK investors to make their money work for them and can add up to a substantial source of passive income in the long term. This guide will give the rundown on what an ISA is, how it works, and how UK investors can get the most from their ISA accounts in 2023.
Best UK Brokers With ISAs
Interactive Brokers is a leading global brokerage that provides access to a comprehensive offering of stocks as well as forex, futures, metals, bonds and cryptos. The firm has over 40 years experience in the online trading industry and is heavily regulated by SEC, FCA, IIROC, and SFC. Day traders can use the proprietary Trader Workstation and can access powerful tools and data feeds as well as comprehensive educational resources.
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Interactive Investor are a hugely respected, FCA-regulated investing firm. The trading platform is easy-to-use while the sign-up and deposit process is straightforward for new investors. ii also has a long track record and a string of industry awards under its belt.
Demo Account Regulated By MT4 Integration No FCA No Min. Deposit Min. Trade Leverage £0 £25 None
IG is an award-winning broker that has an excellent reputation globally. The brand offers spread betting, CFD and forex trading across a comprehensive suite of markets. IG is also multi-regulated, provides a great trading app and has 50 years experience.
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In the 1980s, the Conservative government introduced Personal Equity Plans (PEPs) as a way of encouraging individual investors to buy stocks and shares. All gains made within a PEP were tax-free.
The PEP eventually morphed into the Individual Savings Account (ISA), the most tax-efficient form of investing in the UK today.
Each individual is currently limited to investing a maximum of £20,000 per year in their ISA. This amount is reviewed in every UK budget, and then revised from the start of the tax year on 6 April.
There are three main types of ISA available in the UK: Cash ISA, Stocks and Shares ISA and Lifetime ISA. A recent addition to the list of ISAs is the Innovative Finance ISA, or IFISA, which allows UK residents to invest some or all of their ISA allowance in loans through a peer-to-peer network.
Investors can save their full allowance in any one of these each year, or they can divide their allowance between the four.
The yearly allowance resets at the beginning of each tax year on 6 April – meaning that if you have saved the full £20,000 one year, you can save another £20,000 from that date the following year.
The easiest way to think of a Cash ISA is as a standard bank or building society savings account in which interest is paid gross and is not subject to tax.
Investment can be by way of lump sums or regular payments, though deposits made may not total more than the cash ISA allowance. A withdrawal cannot be replaced by a deposit if it takes the sum of deposits made during the tax year over the Cash ISA allowance.
Cash ISA accounts can be opened on an instant-access basis or for a fixed-term. Fixed-term accounts tend to offer higher rates of interest, but early withdrawals will be penalised.
An investor can transfer a Cash ISA from one provider to another, though again a charge may be made to transfer out of a provider.
Choosing A Cash ISA
When deciding upon which Cash ISA is best for you, there are several things to consider;
- Do you want instant access, or would you be happy to tie your money up for a period of time: if so, how long?
- Shop around for the best rate available, you will find there is a lot of competition for your cash.
- Beware of introductory rates: these are often followed by poorer rates than are available elsewhere.
- Always check out what fees will need to be paid if you want to switch providers, or if in a fixed term investment what the penalty will be for early withdrawal.
Cash ISAs are available from numerous providers, most commonly high street banks and building societies, and can be opened over the counter, by telephone, or online.
Stocks & Shares ISAs
An investor can own a variety of investments within an ISA wrapper and may invest their whole ISA allowance in a Stocks and Shares ISA. Whilst these instruments include the shares of individual publicly traded companies as well as corporate and government bonds, most commonly they are marketed as products in their own right with investment in OEICs (open-ended investment companies), unit trusts, or investment trusts.
However, some online brokers provide Stocks and Shares ISA account holders with the ability to buy stocks in individual companies traded on UK and US stock markets.
As with Cash ISAs, investments can be made by regular contributions or as a lump sum.
Within the ISA, it may be possible to switch funds, though this will be according to the rules of the provider and may incur charges. If an investor wants to transfer his ISA to a different provider, then they will need to ensure that both their current provider and the new provider allow this. A Stocks and Shares ISA cannot be transferred into a Cash ISA.
Dividends paid by investments within an ISA wrapper will be paid with dividend tax paid. This tax cannot be reclaimed. However, all capital gains on investments within an ISA wrapper accrue free of any capital gains tax liability.
Choosing A Stocks & Shares ISA
Before you invest your money into a Stocks and Shares ISA, consider the following:
- A Stocks and Shares ISA is not a risk-free investment. For the potential higher gains, you must accept a level of risk. You should understand what your attitude to risk is and how this affects your investment options before proceeding and selecting your investment.
- Investment into a Stocks and Shares ISA will involve some charges, and these will depend upon the investment made. An investment into a unit trust could incur an upfront charge of, for example, 3% of the amount invested. This will impact investment performance, particularly over the short term. So you should be willing to remain invested for some time to lessen this impact and give the investment time to work.
- Different providers may levy different charges, including investment management charges. Ensure you understand the impact of these charges on your investment before committing to it.
Lifetime ISAs were introduced to replace the old Help to Buy ISA accounts, which were designed to assist in first-time property purchases. The main difference between a lifetime ISA is that they can also be held until the investor turns 60 and used in a similar way to a pension.
Lifetime ISA allowances are limited to £4,000 per year, but any savings up to that amount will be enhanced by an additional 25% paid by the government. So, if you invest the full £4,000 in your Lifetime ISA, the government will deposit an additional £1,000.
The money saved in a Lifetime ISA can be used either to buy a first property valued up to £450,000, or held until the investor turns 60. If the investor accesses the money without meeting these conditions, they will lose the 25% bonus paid by the government, but they will keep any other profits made from the investment.
Lifetime ISAs are available in cash and stocks and shares form, and when choosing a provider, investors should consider the same factors as for these account types.
Innovative Finance ISAs
IFISAs are a relatively new way of using your ISA allowance, allowing you to loan it out through a peer-to-peer network and earn tax-free interest. An IFISA tends to pay out a much higher rate than a cash ISA, with major IFISA providers currently paying out between 4% and 7% per annum. However, IFISAs are comparatively high-risk investments and are not protected by the Financial Services Compensation Scheme.
When choosing an IFISA, it is important to take this risk into account and seek a trustworthy and reliable provider that has a good track record and protection in place for clients’ money.
Ordinarily, ISAs are available for any UK resident aged 18 or older who has a National Insurance Number, but younger savers can also get started with saving in a Junior ISA. These are available in both Cash and Stocks and Shares form, and work in the same way as their fully grown counterparts but with a reduced yearly limit of £9,000.
Bottom Line On ISAs
ISAs allow investors and savers to take some returns on their investments tax-free (except for dividend tax paid within a Stocks and Shares ISA). As non-taxpayers can claim tax back on savings, this is less of an issue for them.
Similarly, all UK residents receive a capital gains tax allowance each year. For those that expect gains of less than this amount, capital gains tax will not be payable.
It could be argued for these reasons that both Cash and Stocks and Shares ISAs have a limited appeal. If non-taxpayers can reclaim tax paid on interest, and investors don’t make gains over the capital gains tax allowance, why then go to the trouble of investing within an ISA wrapper?
Consider the non-tax-paying investor building up savings over a long period: at some point the gains from such investments may take an individual into a new tax bracket, or mount up to more than the capital gains tax allowance. If such savings or investments have been made within an ISA wrapper, then the investor will be protected from paying taxes on them.
Always use as much of your ISA allowance as possible, and remember that any unused allowances expire at the end of each tax year. You will often be protecting yourself from unnecessary taxes either now, or in the future, or both.
What Is An ISA?
Individual Savings Accounts, or ISAs, are tax-free savings accounts that are available to residents of the United Kingdom. ISA account holders can save up to £20,000 per year in these accounts and will not be liable to pay any taxes on the interest in a Cash ISA or on any capital gains in a Stocks and Shares ISA.
UK residents can also open a Lifetime ISA account, save up to £4,000 per year and claim an additional 25% from the government. The savings and bonus can be withdrawn to buy a first home or when the account holder turns 60.
Can You Have More Than One ISA At Once?
UK residents can save up to £20,000 per year in a Cash ISA, a Stocks and Shares ISA, a Lifetime ISA or all three. They can divide their allowance between the different types of ISA accounts as they see fit, but they cannot save more than a combined total of £20,000 per year in their accounts.
Do You Pay Tax On Stocks And Shares ISAs?
Stocks and Shares ISA account holders will need to pay tax on any dividend payments they earn from their investments, but they are exempt from capital gains tax.
Should I Open An ISA Account If I Don’t Earn Enough To Pay Tax?
Most UK residents will probably not be liable to pay any tax on their savings or investments when they first open an ISA account, but that doesn’t mean they shouldn’t open one. If you save consistently for years, you will eventually go over the limit and be liable to pay tax on your savings or investments. An ISA can be particularly useful for investing in stocks and shares, as these can gain value significantly over years of investing.
Can I Withdraw My ISA Funds At Any Time?
Different types of ISA accounts have different terms and conditions relating to when you can withdraw your funds. In a lifetime ISA, you will lose your 25% bonus if you withdraw your funds before you are 60 unless the withdrawal is to purchase your first home. Early withdrawals from fixed-term Cash ISAs may be liable to a penalty.
All ISA account holders should note that the £20,000 yearly limit for deposits is not reset when you make a withdrawal – so, if you open an ISA and deposit £20,000 at the start of the year, then withdraw £10,000, you will not be able to replace the funds. However, you can withdraw funds deposited in the previous tax year.