What is an ISA?

An ISA is a tax-efficient savings or investment vehicle. ISA stands for Individual Savings Account.

ISAs are often described as ‘wrappers’. Savings or investments held inside an ISA wrapper will be free of income tax and capital gains tax (CGT). But other savings or investments, if they’re not held (or ‘wrapped’) in an ISA, could be subject to tax. So ISAs can protect your savings and investments from tax.

ISAs can be contrasted with pensions. Pensions are tax efficient on the way in, as you can get income tax relief on money you put into a pension. But, when you come to make withdrawals from a pension, part of those withdrawals are subject to tax.

ISAs work in the opposite way. You don’t get any tax relief on money you put into an ISA. But you don’t pay income tax or CGT on withdrawals or encashments from an ISA. You are also not liable for income tax or CGT on savings or investments while they’re held in an ISA.

Different ISA types

There are currently five kinds of ISAs available:

• Cash ISAs

• Stocks and shares ISAs

• Innovative finance ISAs

• Lifetime ISAs

• Junior ISAs (JISAs).

Help to Buy ISAs were previously available, but the last date for opening these was 30 November 2019. However savings can continue to be made tax-efficiently into existing Help to Buy ISAs.

People aged 18 or above who are UK residents for tax purposes are eligible to invest in ISAs, although children aged 16 or 17 can invest in adult cash ISAs. The annual allowance for investing in an ISA is £20,000. So anyone aged 18 or above can put up to £20,000 a year into any ISA, while 16 and 17-year-olds can put up to £20,000 a year only into a cash ISA.

It is permissible to invest in all of these types of ISA in a single tax year. But the total amount of collective ISA investments can’t exceed £20,000 in any one year and you can only open one of each type of ISA per year.

This article considers just cash ISAs and stocks and shares ISAs, which are the most commonly used types of ISAs (1).

Cash ISAs

A cash ISA is basically a bank or building society account in which there is no tax charged on interest earned. Cash ISAs can include some National Savings and Investment products or accounts. At Schroders Personal Wealth (SPW) we believe cash ISAs could potentially be a suitable vehicle for holding rainy day funds. We believe the average individual would benefit from holding six months’ of expenditure in rainy day funds, although this depends on individual circumstances.

Stocks and shares ISAs

These can form a key part of your investment holdings, due to their tax efficiency and because they allow you to choose from a broad range of investments. Stocks and shares ISAs can contain the following investments:

• Shares in companies listed on an HMRC-recognised stock exchange

• Unit trusts and investment funds

• Corporate bonds

• Government bonds.

At SPW, we believe in maximising tax opportunities, where these dovetail with your wider financial planning needs. And two of our key principles are to stay invested in the markets and to invest for the long term. Stocks and shares ISAs can allow you to stay invested in the markets for the long term in a way that is highly tax-efficient. This makes them a valuable financial planning tool.

Crucially, ISA investments can build up substantially over time. Consider a couple who are married or in a civil partnership and invest a combined £40,000 a year into stocks and shares ISAs. They would build up £400,000 in ISA investments after ten years. But this could amount to significantly more with investment growth, although such growth is not guaranteed and investments can fall in value.

A key benefit of ISAs is that the tax benefits can be passed on to spouses on death. But, unlike pension savings from defined contribution (DC) pensions, ISAs are not free of inheritance tax (IHT).

ISAs can form a key part of tax planning and wider financial planning. You may benefit from speaking with a financial adviser to find out how they can work for you and your unique circumstances. At SPW, one of our key principles is to have regular reviews with a financial adviser. We believe this can help ensure you remain on track to meet your goals.

(1) Gov.uk, ‘Commentary for annual savings statistics: June 2022’, 25 November 2022.

Much of this article is based on the following sources:

Gov.uk, ‘Individual Savings Accounts (ISAs)’, 10 July 2023.

Money Helper, ‘ISAs and other tax-efficient ways to save or invest’, 10 July 2023.