Individual savings accounts (Isas) offer a number of benefits: no further tax is payable on income or interest from investments held within them, and when you sell investments in an Isa they don’t incur capital gains tax (CGT).
You can put investments worth up to £20,000 a year into an Isa and, unlike with a pension, there is no Iifetime limit. Although you do not get tax relief on investments you put into an Isa, you do not pay tax when you take out your money, making it a great vehicle from which to draw retirement income. Not that you have to wait until age 55 to access your money with most types of Isa – unlike with pensions.
And you can hold a wide range of investments in Isas, including shares, funds, investment trusts, exchange traded funds (ETFs), cash and peer-to-peer loans.
But if you really want to benefit from Isas you need to do more than just throw money into them. The way you use them and incorporate them into your wider financial planning can make a big difference to your overall wealth, so we have set out 10 tips to get the most out of your Isa.
1 Use it or lose it. If you don’t use your Isa allowance each year the opportunity to hold assets worth up to £20,000 tax-efficiently is gone – you cannot carry forward unused allowances from previous years.
If you are not sure what to invest in you could temporarily hold your annual Isa allowance in cash and invest at a later date, although cash is definitely not good for the long term because inflation erodes its value. Or drip-feed set amounts into investments at regular intervals so you buy more shares or units when prices are low, and fewer when they are expensive.
And use your Isa allowance sooner in the tax year rather than later, advises Martin Bamford, managing director of Informed Choice, to allow compound returns to really add up.
If you don’t have £20,000 in new money to invest then transfer any investments outside a tax-efficient wrapper into an Isa.
2 Bed and Isa. This is where you sell investments outside your Isa, offsetting any CGT against your annual allowance of £11,300. You then repurchase the same investments within your Isa so that they can grow tax-efficiently and you don't have to disclose them on your annual self-assessment return.
But make sure you leave enough time to do all this before the end of the tax year on 5 April.
If you still have unwrapped investments after using this year's £20,000 Isa allowance then consider doing a:
3 Bed and spouse. This is where you give assets to a spouse or civil partner, a transfer that doesn’t incur CGT. They could then sell some or all of these, offsetting the CGT against their £11,300 annual allowance, and repurchase them within their Isa.
4 Wrap the right investments. If you can’t get all your assets into a tax-efficient environment using your and your spouse’s allowances, give priority to the ones likely to incur most tax. This tax year you have a dividend tax allowance of £5,000, but from 6 April this falls to £2,000. So hold equity income investments and dividend-paying property funds in a tax-efficient environment.
“Any dividend income in excess of [your £2,000 allowance] will be taxed at 32.5 per cent if the investor is a higher-rate taxpayer for income tax purposes and a rate of 38.1 per cent if they are an additional-rate taxpayer,” explains Jason Hollands, managing director at Tilney Group.
Remember that you have an annual £11,300 CGT allowance to use when selling capital growth assets held outside a tax wrapper, and gains on these can be offset against losses.
Cash is not an Isa priority because interest on this can be offset against your personal savings allowance, currently £1,000 a year for basic-rate taxpayers and £500 a year for higher-rate taxpayers. With interest rates at low levels it would take a lot of cash to breach these allowances.
But if you are an additional-rate taxpayer paying 45 per cent income tax then you don’t have a personal savings allowance, so consider holding your cash in a tax-efficient environment.
5 Use your Isa first. If you have significant assets and expect to breach your annual inheritance tax (IHT) allowance of £325,000 (or £425,000 if you are passing on a family home to children), it may make sense to leave your pensions untouched for as long as possible. These can be passed on to children, grandchildren and other beneficiaries tax-efficiently. If you die before age 75 pension assets can be received entirely tax-free, and if you die at age 75 or older your beneficiaries will pay tax on these at their marginal rate when they draw on them.
“Pensions are very attractive from an estate planning viewpoint, so don’t initially use them to fund retirement,” says Mr Hollands. “Use your Isas to generate tax-free income and crystallise capital on assets outside of them, offsetting the tax against your CGT allowance. Then run down your Isas as you can’t pass them on tax-efficiently, unless to your spouse, and leave your pension untouched for as long as possible. Isas cannot be inherited across generations like pensions.”
6 Take advantage of the Lisa loophole. If you opened a Help to Buy Isa (Hisa) the amount in it on the day the Lifetime Isa (Lisa) was launched – 6 April 2017 – can be transferred into a Lisa without making a dent in your annual contribution limit, as long as it is completed before 6 April 2018. After this, if you transfer your Hisa into a Lisa it will eat into your annual allowance of £4,000.
“For example, if you had opened a Hisa on the first possible day in December 2015 and saved the maximum possible you would have contributed £4,400 to your Hisa by 5 April 2017, the day before the Lisa was introduced,” explains Sarah Coles, personal finance analyst at Hargreaves Lansdown. “This could all be transferred into a Lisa and you would receive the 25 per cent bonus on all of it in April, worth £1,100. You could also transfer the contributions made after April 2017, which at most by 1 February this year would be £2,000. This would come out of the 2017-18 annual limit, but you can then top this up to the £4,000 maximum by 5 April 2018, and receive the government 25 per cent bonus of £1,000. It means you would receive government top-ups of £2,100 in April rather than the usual annual limit of £1,000.”
“The money needs to be with your Lisa provider by the end of the tax year to take advantage and our analysis shows that most transfers take just under two weeks. A transfer from a Hisa to a stocks-and-shares Lisa should take no longer than 30 days, but in some cases it has. If you want to be sure of completing a transfer before the end of the tax year, you need to get cracking and apply sooner rather than later.”
7 Open a Lisa while you can. You can’t open a Lisa after age 40 so even if you are not looking to buy a first property or currently don’t have much to save for retirement, it is still worth opening one so that you have the option of using this wrapper at a later date. You can put up to £4,000 a year into a Lisa and the government will pay a bonus of 25 per cent of what you put in until you are age 50.
8. Use your Isas for children first. You may be tempted to open a Junior Isa for your children, into which you can save £4,128 this tax year. However, when your children turn 18 they will get control of the assets in these. And what they do with them may not be the purpose you intended for the money. So if you are not using all of your and your partner’s annual Isa allowances of £20,000, save for your children in these and give them the money at a time you choose for the purpose you have designated.
9 Transfer CTFs into Junior Isas. However, if you opened a Child Trust Fund (CTF) for any of your children transfer it to a Junior Isa. You typically get better rates on cash in these, and as Junior Isas tend to offer more investment choice than CTFs you should be able to invest them in funds with much lower charges, advises Ms Coles.
10. Parent priority! If you and other relatives are investing sums for a child in excess of the £4,128 Junior Isa allowance, use the Junior Isa for sums contributed by the parents, and a bare trust for funds contributed by grandparents and other relatives. “This is because Junior Isas fall outside the rule that when a child earns £100 or more in interest it is taxed as belonging to the parent [if it’s above the parent’s personal savings allowance],” explains Ms Coles. The £100 limit on funds outside an Isa does not apply to others, such as grandparents.
For the rest of our 50 Isa ideas and other associated Isa articles see below:
10 investment trusts for your Isa
The cheapest DIY platforms on which to hold your Isa
