A guide to ISAs

ISAs, officially Individual Savings Accounts, offer a tax-efficient way to save and invest, making them an extremely attractive option for both regular savers and those with lump sums.

Since ISAs were launched in 1999 they have become one of the most popular savings products in the UK, allowing individuals to put away sums tax-efficiently. What do you need to know about them?

There are four principal types of ISA: cash ISAs, stocks and shares ISAs, Innovative Finance ISAs and Lifetime ISAs.

• Cash ISAs are available to people aged 16 or above and are cash accounts that typically offer competitive rates of interest. From April 2024 the age will rise to 18.

• Stocks and shares ISAs and Innovative Finance ISAs are available to people aged 18 or above and typically hold stock market investments such as shares and investment funds.

• Lifetime ISAs, meanwhile, are only available to those between 18 and 40 and are intended for those saving for a first home or later life savings.

Each type of ISA has different features and serves a different purpose, but they all offer the same tax-efficient benefits. You are not liable to pay tax on any interest earned on cash in an ISA, nor will you pay income, dividend or capital gains tax on any investments held in an ISA.

Across cash, stocks and shares and Innovative Finance ISAs, you may save up to £20,000 in total each year. However, only £4,000 can be paid into the Lifetime ISA in a financial year, to which the government also adds a 25 percent contribution. You may hold multiple ISAs, but the total annual allowance is capped at £20,000.

For example, you may put £13,000 in a cash ISA, £4,000 in a Lifetime ISA and £3,000 in a stocks and shares ISA in a single tax year.

At present, you can hold multiple ISA subscriptions of each type, but you can only open one of each type in a single tax year. But from April 2024 you will be able to invest in multiple ISAs of the same type in a single tax year.

Flexible cash ISAs offer tax-efficient withdrawals

For most ISAs, you may take money out at any time, although there may be restrictions or charges. Some ‘flexible’ cash ISAs allow you to take cash out of your account without it affecting your tax allowance for the year. Let’s say you put £20,000 into a flexible cash ISA in the current tax year but then decide to withdraw £1,000 of it. With a flexible cash ISA, you would be able to add back that £1,000 later on in the same tax year.

You may also transfer your ISAs from one provider to another at any time and from one type of ISA to another, but there may be a charge. Transfers should take no more than 15 working days between cash ISAs and no more than 30 calendar days for other types of ISA.

You cannot transfer an ISA allowance or open a joint ISA with anybody else. However, with certain types of ISA, such as the Lifetime ISA or Help to Buy ISA, you can pool your savings with a partner to purchase a property.

In some circumstances, you may inherit the money invested in ISAs from a spouse or partner along with their ISA allowance for that tax year. In addition to your allowance, you can add a tax-efficient amount up to the value held in their ISAs when they died or the value of their ISAs when they were closed.

If you move abroad, you cannot put any money into an ISA after the tax year you moved, and you must tell your provider that you have stopped being a UK resident. However, you can keep your ISA open and claim tax relief on any cash and investments held in it. You can pay into your ISA again if you return and again become a UK resident.

When you die, the ISA will end when it is closed by the executor of your estate or when the administration of the estate is completed. Otherwise, the ISA provider will close it three years and one day after your death.

The original ISAs

Cash ISAs and stocks and shares ISAs are two of the longstanding products available for savers, and the easiest to understand.

Cash ISAs can include savings in bank and building society accounts, and some savings from National Savings and Investments, the government-owned bank. Many banks and building societies offer cash ISAs, including low-interest instant access accounts or higher interest accounts where savings are locked up for a certain period, or withdrawals are limited.

Stocks and Shares ISAs allow you to hold a range of different types of financial assets, such as company shares, investment funds, corporate bonds and government bonds. Investment and wealth management companies and fund platforms are more likely to offer stocks and shares ISAs.

Newer innovations

The Lifetime ISA and Innovative Finance ISA are two relatively recent initiatives the government introduced to serve different purposes.

The Lifetime ISA, or LISA, was launched in 2017 and designed to help people buy their first home or save for later life. They are offered by a range of different financial institutions, including banks, building societies and wealth managers.

You can hold both cash and the same types of financial assets that are held in stocks and shares ISAs. A maximum of £4,000 a year may be contributed until the age of 50, included within the overall £20,000 ISA allowance, with the government contributing a bonus of 25 percent capped at £1,000 a year.

If you’re buying a first home, then please note that there are several conditions for using the Lifetime ISA and its government bonus:

• The property must cost £450,000 or less

• You must purchase the property at least 12 months after you make your first payment into the Lifetime ISA

• You must buy the property with a mortgage

• A conveyancer or solicitor must be used for the purchase, as the ISA provider will pay funds directly to them.

If you’re buying a first home with someone else, you may both use your Lifetime ISA savings and the government bonus, but you must both be a first-time buyer and meet all the other requirements.

Savings can only be withdrawn from the LISA if you are buying your first home, aged 60 or over, or are terminally ill. There is a 25 percent withdrawal charge for any other reason. If you die before 60, the Lifetime ISA ends on the date of your death, and there is no charge to withdraw the funds or assets from your account.

If you transfer cash or assets from a Lifetime ISA to a different type of ISA before 60, you must pay the 25 percent withdrawal fee.

The Innovative Finance ISA was introduced in 2016 and is offered by a smaller range of specialist providers. It was launched to facilitate tax-efficient investing in non-bank lending, specifically peer-to-peer loans and crowdfunding debentures. [SW1] Peer-to-peer lending enables you to lend to individuals or small businesses, bypassing the need for bank involvement. Crowdfunding debentures enable you to invest in businesses by buying debentures, which act like bonds.

From April 2024, Innovative Finance ISAs will also be able to hold long-term asset funds (LTAFs). LTAFs offer long-term investors access to a wide range of assets that are not usually available to stock market investors, including private market investments.

In addition, open-ended property funds with extended notice periods will also be eligible for Innovative Finance ISAs from April 2024. Property funds that you can sell on a daily basis can struggle to cope if they face mass sell-offs from investors. That’s because they would need to sell underlying properties to pay the investors back and this is difficult to do at short notice. Extended notice periods give fund providers time to sell underlying property holdings.

Cash can be transferred from an Innovative Finance ISA to another provider, but you may not be able to directly transfer the investments from it.

Other types of ISA

The success of ISAs has led to several variations in the years since their launch. For instance, Junior ISAs, or JISAs, have grown in popularity as a savings vehicle for children under 18 since the Child Trust Fund scheme closed in 2011.

Junior ISAs are available in both cash and stocks and shares versions, and children may have one of each. Many banks and building societies offer them, as well as several investment and wealth management companies. Children can take control of their JISAs at 16 and are able to withdraw money from the accounts at 18. The savings limit for a Junior ISA currently stands at £9,000 per year.

Some savers may also be invested in Help to Buy ISAs, but these are no longer available for new savers. Existing savers can pay in up to £200 per month, with the government providing a 25 percent top-up, up to a maximum of £3,000 over the life of the ISA. Existing savers can continue to pay into the ISA until November 2029 and claim the government bonus until November 2030. The home must have a purchase price below £450,000 in London or £250,000 outside of London.

ISAs can play a key role in tax planning and wider financial planning. You may benefit from speaking with a financial adviser who can help assess how they can work for you and your particular circumstances. At Schroders Personal Wealth, one of our key principles is to have regular reviews with a financial adviser, to help ensure you are on course to meet your goals.