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The IC guide to ISAs

The complete guide to Individual Savings Accounts (Isas)
The IC guide to ISAs

Key Points: 

  • An Individual Savings Account (Isa) is a wrapper that allows you to grow savings free of tax. 
  • You have an annual ISA allowance which is the amount you can add to the account in any given year - the current allowance is £20,000 (for 2020/21 tax year). 
  • There are different types of Isa but one allowance for all your accounts.
  • You have until the 5th of April each year to use up your ISA allowance - if you don’t it will be gone. 

Savers and investors take note. All of the money outside of your pension can be subject to taxes on profits and dividends. But the money in Individual Savings Accounts (Isa) is exempt from these taxes. That is why it is efficient to use up your allowance where you can. 

Isa tax benefits 

 

Who can have an ISA?

All UK residents can have Isas, while junior Isas are available for children under the age of 18, and must be set up by a parent or legal guardian before the child is 16. The current Junior Isa allowance is £9,000. From 16, you can open your own cash Isa and from 18, you can open a Stocks and Shares Isa, Lifetime Isa (if you’re under the age of 40) and Innovative Finance Isa.   

Types of ISA

1.Stocks and Shares ISAs

By investing, you can grow your money over time. It is generally advised that you invest with a time horizon of at least five years, to boost your chances of outperforming cash saved in the bank. 

Don’t underestimate the power of compound growth. According to IG, FTSE 100 total returns grew at an annualised rate of 7.75 per cent from 1984 to 2019. A £10,000 investment would be worth £136,334 after 35 years if it grew at 7.75% per year. 

But manage your expectations. Changing market conditions can be difficult to stomach for nervous investors. 

2. Cash ISAs

If you have a low risk tolerance or think you might need access to your ISA money within the next few years, it might be more sensible to put money into a cash Isa. Cash Isas currently pay very low levels of interest so the tax benefits may be minimal, but it is good to keep as much money as possible within the wrapper. 

Make sure you shop around for a good interest rate for the duration of the term you are looking for, and keep an eye out for high rates that drop after their initial period. You can always transfer an Isa between providers later if you find a better rate elsewhere.  

3. Lifetime ISAs

Lifetime Isas were designed to give a boost to people when buying their first property, and encourage people to save. You can set one up between the ages of 18 and 40, and put up to £4,000 into it each year. You can keep contributing until your 50th birthday, and the government will add an extra 25 per cent, up to £1,000 a year. As with all Isas, it is free of UK tax. The government will pay the bonus each month (or however often you pay into your account), and your platform or bank should claim the bonus for you.   

The maximum bonus is £33,000 (unless the rules change). You’d need to put £4,000 in each year from age 18 up until you are 50 to get that. There are strict rules about when you can take money out of a Lifetime Isa without paying a withdrawal charge. You can access your money if you’re buying your first home (with a purchase price of up to £450,000), or if you are over the age of 60.  

4. Innovative Finance ISAs

These are for peer to peer lending - a form of investing where you directly lend money to borrowers and businesses for a fixed amount of time and they pay you back with interest. Like all other Isas, your money is free from UK income and capital gains tax.

Interest rates can look very generous on these products, but, generally, the higher the rate -  the more likely you are to lose money. 

It is very difficult to do due diligence on these products so unless you really know what you are doing it is probably best to steer clear. 

 

Next steps - using your Isa allowance 

Picking a provider

You can only use one Isa provider for your Isa allowance in the current tax year, but you can use a different provider in subsequent years and transfer existing Isa money among providers. 

Stocks and shares Isas are offered by a range of platforms - with varying ranges of cost, service levels and product offering. View our guide to platform Isa charges.

Investing in an Isa

We have created basic asset allocations for savers at different stages of their investment journey. You can find out how to save for your Isa in our basic guides.

 

ISA summary

ISA 

Description

Key terms*

Stocks & Shares ISA

Investment account

£20,000 allowance, no dividend tax or CGT payable

Cash ISA

Savings account

£20,000 allowance, tax free interest

Lifetime ISA

Savings/ investment towards house deposit or retirement

£4,000 allowance, govt adds 25% to contribution. Bonus paid back if not used for house purchase (first time buyers only) or retirement. Only those aged 18-39 can open. Tax free returns 

Innovative Finance ISA

Peer to peer lending

£20,000 allowance, tax free interest

Junior ISA

Savings or investment account for children (up to age 18)

£9,000 allowance, tax free returns

Help to Buy ISA

Savings account for first time buyers

Closed to new savers. Can pay in £2,400 for 25% top up. Tax free interest

*all allowances apply to 2020/21 tax year.