What is an ISA?
Individual Savings Accounts (ISAs) are a way of saving and investing without paying any tax on the returns you make. Launched in the UK in 1999 to encourage more people to save and invest, ISAs allow you to earn interest on your savings without paying tax on it or invest in stocks and shares without being liable for tax on any returns you make.
ISAs were introduced to replace Personal Equity Plans (PEPs). Initially savers had the option of a mini ISA, which allowed investments in either cash or stocks and shares, or a maxi ISA, which combined both elements in one account. Cash ISAs and stocks and shares ISAs replaced the mini and maxi ISAs in 2008. In July 2014, the ISA allowance was raised to £15,000 per person, and since 6th April 2016, the current 2016/17 tax year allowance stands at £15,240 which this can be divided between cash and investments in any proportion you wish.
Why should you be using your ISA allowance in 2016?
It’s well-known that most of us in the UK aren’t saving enough money – in fact, it’s believed that around 8 million British adults have no savings at all. With the Bank of England base rate at a record low at the time of writing, it’s essential to compare your savings options before you make a decision, to ensure you get the best deal possible.
The primary benefit of ISAs is the tax advantage that allows individuals to profit from savings or shares without paying income or capital gains tax on that return. The secondary benefit is that you are saving some of your income. Whether you've a particular savings goal in mind or you just want to ensure you've got an emergency fund tucked away, an ISA can provide a simple way to help achieve this.
For UK residents, ISAs should be your first savings port of call in order to avoid paying tax unnecessarily on your savings or investments. Different ISAs are designed to meet different needs, so before you choose an ISA provider you should ask yourself a few questions.
What types of ISAs are available?
1. Instant access cash ISAs
Instant access cash ISAs are very popular as they’re relatively simple and convenient, but consumers should shop around for the best rate as some are more competitive than others. These accounts are useful for being able to access funds in a hurry, but with the return on interest low on instant access accounts, there is an incentive to keep saving and contributing to a more profitable account. Use our services to compare instant access cash ISAs.
2. Easy access cash ISAs (also known as notice accounts)
Notice accounts provide a better rate if interest than instant access accounts, but require more notice to withdraw cash –this can range from a few weeks to several months, so check carefully beforehand. Use our services to compare easy access cash ISAs and notice accounts.
3. Fixed-rate cash ISAs
Fixed-rate cash ISAs have traditionally been the savings vehicle of choice for those looking to lock cash away for a set period of time in the hope of gaining a better interest rate in return. However, the current combination of a low base rate plus the funding for lending scheme leaving many banks less reliant on income for savers means that these accounts are often no longer a guarantee of high rates. Compare fixed rate cash ISAs and fixed rate cash ISA alternatives using our services.
4. Deposit plan cash ISAs (also known as structured deposits)
As an alternative to traditional cash ISAs, you may want to consider structured deposit plans. This type of account offers the potential for higher returns than those available via fixed-rate cash ISAs, by offering returns linked to an index (usually the FTSE 100). Your returns are based on market performance, but your capital is protected by the FSCS up to a value of £75,000. Use our services to compare structured deposit ISAs.
5. Investment ISAs (also known as stocks and shares ISAs)
A stocks and shares ISA allows you to invest money up to a certain amount without paying tax. You can choose from options including income ISAs, growth ISAs, and share dealing ISAs. Use our services to compare investment ISAs.
How to choose an ISA
The terms and conditions of ISA often vary slightly depending on which ISA manager you choose, so it’s essential to check things like:
- The minimum balance requirements
- Any limits on transfers into the account – some accounts set limits on this
- Notice periods and penalty fees, if these apply
It’s also important to ask yourself a few questions before you start, such as:
How much of my annual ISA allowance do I want to use?
Each UK resident over 16 has an annual ISA allowance, which is set at the start of each tax year by HMRC. The tax year runs from 6th April each year, and the current ISA allowance as at 6th April 2016 is £15,240.
How much tax will I save with an ISA?
The good news is that whatever your tax bracket, you'll pay 0% tax on any savings held in a cash ISA. People in all tax bands can benefit from this, as you can see below:
- Savings rate taxpayers usually pay 10% tax on savings interest – with a cash ISA you pay 0%
- Basic rate taxpayers usually pay 20% tax on savings interest – with a cash ISA you pay 0%
- Higher rate taxpayers usually pay 40% tax on savings interest – with a cash ISA you pay 0%
- Additional higher rate taxpayers usually pay 50% tax on savings interest – with a cash ISA you pay 0%
A stocks and shares ISA allows you invest your tax-free allowance while only paying 10% tax on any investment income you make. This can add up to a substantial saving when you consider that, on dividends paid on a non-ISA investment, an additional rate taxpayer would have to part with 42.5% in tax.
The above information gives you a general idea of what you could save - remember that it depends on your individual circumstances and may be subject to change in the future.
What if I need to get to my money out of the ISA quickly?
If this is important to you – for example, if you’re saving for a short-term goal or to build up an emergency fund, rather than for long-term growth – then an instant access or easy access cash ISA may be a good option for you.
Choosing an ISA provider
ISA providers are known as ISA managers. They can include banks, building societies, fund managers, stockbrokers, and financial advisers. ISA managers must be authorised by the Financial Conduct Authority (FCA) and approved by HM Revenue and Customs. While the approved status of an ISA manager does not guarantee the quality of ISA manager's performance, or that an ISA investment will deliver a satisfactory return, it does provide access to regulatory procedures if things go wrong. This includes the FCA complaints procedure, the Financial Ombudsman Scheme and the Financial Services Compensation Scheme, if applicable.
When shopping around for ISAs you’re likely to encounter introductory bonus rate, which can appear very attractive. However, these rates are only payable for a set period of time, after which the rate will drop – sometimes by a lot. To combat this, you should be ready to shop around for the best rates once your bonus period comes to an end.
Making contributions and withdrawals
Because of the tax advantages of ISAs, there are rules governing contributions and withdrawals. Contributions are subject to annual limits. From 6th April 2016 the annual limit is £15,240, all or part of which can be saved in either a cash ISA or a stocks and shares ISA. Unlike previous years, you can now use your full ISA allowance in cash - previously, you could only hold half your ISA allowance as cash.
Withdrawals may be permitted depending on the type of ISA you opt for. If you have invested your full allowance during the tax year and then withdraw some of the cash, you will not be able to contribute any more to your ISA during that tax year.
Transferring an ISA
You can usually transfer any money held in ISAs from previous tax years into a new ISA, even if this amount is greater than the annual allowance. You can transfer funds from a cash ISA to a stocks and shares ISA, and vice versa. All ISA transfers should be carried out properly, via your existing ISA manager, in order to retain the tax-efficient status of your capital.
Top 10 tips for using your ISA allowance in 2016
- Remember that you can't carry your tax-free allowance over from one financial year to the next - so if you've got enough cash to hit your limit, stash it in an ISA. The ISA allowance for the financial year 2016/17, as of 6th April 2016, is £15,240.
- Always keep an eye on your bonus rate, and be prepared to switch when it ends.
- You can only have one type of cash ISA in each financial year, so research your options carefully. Whether you choose a fixed-rate or instant access cash ISA, give some thought to your savings goals beforehand to help you determine what's right for you.
- If you’re completely new to saving, or just need a tax-efficient place to build up an emergency fund, a cash ISA can be a good option. It's a good way to try your hand at saving without committing yourself to anything long-term.
- Make the most of your ISA allowance each tax year and keep up to date with changes in annual limits. Remember that you can’t carry over any unused ISA allowance – so use it before it’s too late.
- Having goals can be useful for motivation. Saving for a holiday or other project can be a great way of maintaining focus. An instant access or fixed-rate cash ISA can offer a simple way to save for something specific like a holiday, home improvements, or a new car.
- If you know you’re likely to forget to make regular deposits in your ISA, set up a direct debit for whatever amount you can comfortably afford at the beginning of each month and you’ll never miss a payment again.
- You should be prepared to invest for the medium to long term with a stocks and shares ISA - for example, for five years or more. If you think you might require access to your cash in the next couple of years, a stocks and shares ISA may not be the right choice for you.
- Always remember that share prices can be very variable - especially in the current financial climate - and so if you were to withdraw your investment in the next twelve to eighteen months, you could end up with less money than you started with.
- With ISAs of all types, the deals on offer are in constant fluctuation, so shop around to ensure you’re always maximising the interest on your savings.
See the table below for a summary of the current ISA allowances and rules.
Types of ISA
2016/17 - £15,240 per individual
You must be 16 or over and a UK resident or Crown employee.
Transfers in from other ISAs from previous years are permitted.
You can save all or part of your £15,240 ISA allowance in a cash ISA.
Stocks and Shares ISAs
2016/17 - £15,240 per individual
You must be 18 or over and a UK resident or Crown employee.
Transfers in from cash or stocks and shares ISAs from previous years are permitted.
You can save all or part of your £15,240 ISA allowance in an investment ISA,
£4,080 per annum per child
The child must be under 18 and live in the UK.
The child must not already hold a Children's Trust Fund (CTF) account.
The child can have both a junior cash ISA and a junior stocks and shares ISA in any given tax year, as long as total amount invested during the year is no more than £4,080.
If child is under 16 someone with parental responsibility must open the Junior ISA (registered contact).