The Beginners Guide to ISAs
When flicking through the money pages in your paper or browsing savings articles online, you’ve probably seen the term ISA but many people don’t fully understand what an ISA is or how it could benefit you.
If you are baffled by financial jargon, then you are not alone. Personal finance expert Andrew Hagger, has put together this simple guide to help you make sense of ISAs and how they work.
What is an ISA?
Introduced by the government in 1999, ISA stands for Individual Savings Account, and was designed to encourage people to save more by offering tax free income.
Each tax year, you are given an ISA allowance, stating the maximum you can save tax-free from 6th April to 5th April the following year. (currently the allowance is £20,000).
There are six different types of ISA – here’s a quick rundown of each and how they differ:
1) Cash ISA – this is the most straightforward ISA and is available to anyone aged 16 and over.
The cash ISA is a tax-free savings account enabling you to save via a regular standing order, ad hoc deposits when it suits you or a single lump sum payment.
Most banks and building societies offer Cash ISAs, ranging from easy access accounts where you can get at your money quickly if needed, through to fixed rate ISA bonds where you lock your money away for a term of between 1 and 5 years in return for a higher interest rate.
As with standard savings accounts, interest rates are quite low at present but on the plus side, cash ISAs offer a risk-free way to save as your balance (up to £85,000) is protected by the Financial Services Compensation Scheme (FSCS) in case your bank or building society goes bust.
The maximum you can deposit in a Cash ISA in the current tax year 2018/19 is £20,000.
2) Stocks and Shares ISA – as the name suggests this is a tax efficient way of buying stock market investments and, as with the cash ISA, you can currently invest up to £20,000 per tax year.
You must be 18 or over to open a stocks and shares ISA
Your money can be invested in shares in public companies (equities), government bonds or investment funds and is considered a medium to long term investment.
Stock market investing can potentially generate higher returns than a Cash ISA, but they also carry a greater risk.
Although any income received is tax-free, it’s important to remember that the value of your investment could go down as well as up.
There are often more fees associated with a stocks & shares ISA and providers may charge you for opening an ISA, changing investments, or switching to another ISA provider.
3) Innovative Finance ISA (IFISA) – this is a relatively new ISA option introduced in 2016.
An IFISA enables you to use some or all of your £20,000 annual ISA allowance to earn tax-free interest returns on money you lend through FCA regulated peer-to-peer providers to people or businesses.
Some IFISA providers only lend your money to individuals while others may concentrate on business lending or with companies involved in property development.
IFISAs tend to offer higher returns than Cash ISAs and are generally less volatile than stocks and shares ISAs, however, because the money you invest is being lent out, there is a risk that the borrowing may not be fully repaid and your capital is therefore at risk.
Many Peer to Peer providers and platforms take precautions to minimise this risk in different ways, including spreading your funds across multiple loans rather than lending it all to a single borrower, however this depends on the platform. Additionally it is worth noting that unlike a cash ISA this is not covered by the FSCS.
4) Junior ISA (JISA) – this type of ISA is designed for children under 16 years of age.
The annual allowance is currently £4,260 and parents have the choice of investing for their child in cash or stocks & shares, or if they wish they can split the allowance between the two.
Although the JISA is in the child’s name it is opened and managed by the parent.
The child can take control of the account when they’re 16 but can’t withdraw the money until they turn 18, at which time it’s legally their money to do what they want with.
5) Help to Buy ISA – this is a specific Cash ISA only available for first-time house buyers.
- You can save £1,200 in the first month, then £200 per month from then on.
- When you’re ready to buy your property, the Government will add 25% of your balance as a bonus (maximum bonus is £3,000).
As this is a type of Cash ISA, you can’t pay into both a Cash ISA and a Help to buy ISA in the same tax year.
5) Lifetime ISA (LISA) – this is only available to people aged between 18 and 39 (at the time of opening) who are either looking to buy their first home or are saving specifically for their retirement.
You can deposit up to £4,000 per year and get a 25% bonus from the government on the amount you save.
The bonus is paid monthly (if you make a deposit that month), and you’ll continue to get bonus contributions up to the age of 50.
If, however, you take the money out for anything other than buying your first home or retirement, there is a penalty of 25%.
How many ISA’s can I have?
In the past there were some very specific rules on how you could split your ISA allowance, but now there’s more flexibility.
Although the amount you can save is currently capped at £20,000 – you now get to choose whether you want to split this between stocks & shares ISAs, cash ISAs, innovative finance ISAs, Help to Buy ISAs and the new Lifetime ISA, and how you much you put in each.
However, be aware there's a limit to how much you can put in the last two.
For example, you can only put £4,000 in the Lifetime ISA every year, which means you could put the remaining £16,000 into any of the other options.
If you decide to spread your money between different ISA types, it’s your responsibility to make sure you don’t go over your £20,000 total ISA allowance.
Providers will usually make sure you don’t exceed the limit in any one account, but they have no record of what ISAs you have elsewhere.
Examples of how you could use your ISA allowance:
- Put the full £20,000 in a cash ISA, invest the whole allowance in a stocks and shares ISA or put it all in an IFISA.
- Adopt a mix 'n' match approach and split the allowance between cash, stocks & shares and innovative finance ISAs, how much in each is down to you.
For example, you could invest £10,000 in a cash ISA, £5,000 in a stocks & shares ISA and £5,000 in an innovative finance ISA. The only rule is that, combined, your tax-free ISA savings in the current (2018/19) tax year don't exceed £20,000.
You must save or invest by 5 April (tax year end) for it to count for that year’s allowance. Any unused allowance doesn't get carried over to next year – so if you don't use it, you lose it for good.
You'll get a new allowance the next tax year but any unused allowance from previous years cannot be brought forward.
Can I transfer my ISAs?
You can transfer ISAs from both the current tax year and previous years to a new provider. Just like your household bills, switching providers could help you get a better rate.
Transferring an ISA is not as simple as withdrawing cash from your bank account and depositing somewhere new.
Don’t withdraw the money yourself, otherwise you lose your tax benefit. Instead, speak to your new provider and ask them for an ISA transfer form. Normally they will then arrange the transfer for you.
Be aware that Stocks & Shares ISAs often charge a fee for transferring, withdrawing or closing an ISA. Other ISA providers may also charge a fee so ensure you check this before deciding to transfer.
Current tax year's cash ISA. You can move the whole balance to another cash ISA, or into a stocks & shares ISA or IFISA. You can't split it between more than one provider.
Current tax year's stocks & shares ISA.You can move (the whole balance only, not part) to another stocks & shares ISA, IFISA or a cash ISA, but you can't split it between more than one stocks & shares ISA.
For Cash ISAs from previous tax years. You can move ALL of these to a new single cash ISA, stocks & shares ISA, or IFISA or you can SPLIT them between more than one cash ISA , stocks & shares ISA or IFISA
For Stocks & shares ISAs from previous tax years. You can move ALL of these to a new single stocks & shares ISA, IFISA or cash ISA, or SPLIT them between more than one stocks & shares ISA, IFISA or cash ISA.
For more details on any of the terms and rules regarding ISAs please check the official government website.
'The Beginner's Guide to ISAs' is an article from Crowdstacker's new, free quarterly financial lifestyle magazine 'Fixed'. Read more insightful articles about personal finance, travel, technology, money saving tips and more by subscribing to Fixed magazine here.