When it comes to ISAs (Individual Savings Accounts) there are now 5 different types, but which is the best ISA for you?
Did you know that in some circumstances you can actually save and invest more than the current £20,000 annual ISA limit?
There are some key rules to be aware of when it comes to ISAs to ensure you handle them correctly and don’t lose out.
Best ISA for each scenario
Paying money into an ISA is a great way to save and invest in your future.
Think:
- Building a fund for your children.
- Saving for your first home.
- Retirement nest egg.
They are a great compliment to a pension as any interest, investment dividends and capital growth you achieve inside the ISA is all tax free. There is no tax to pay on taking withdrawals or income from your ISAs.
When it comes to the best ISA option for you, let’s look at the differences between them.
Cash ISAs
A cash ISA is another form of savings account. You will earn interest from a bank or building society tax free.
In recent years the interest rates on cash ISAs have been very poor and therefore it is often hard to beat inflation unless you go for a fixed term ISA and lock your money away for longer.
A cash ISA is the best ISA option if you will need access to the money in the short term and/or are a higher rate taxpayer and don’t want to pay higher rate Income Tax on the interest you earn.
Junior ISAs
If you have young children or grandchildren and want to build up a fund for them for when they are say 18, then a Junior ISA is a great way to do this.
You can pay up to £9,000 each year into a Junior ISA (so smaller than the normal £20,000 limit) and the money can be saved into a cash version or a stocks and shares version. You could have one of each in each tax year as long as the combined contribution into the two is no more than £9,000.
The child can control the Junior ISA from age 16 but can’t withdraw until they are 18.
Anyone can pay money into a Junior ISA, but it must be opened by a parent or legal guardian.
Stocks and Shares ISAs
By putting your money into a Stocks and Shares ISA you can invest in individual company shares or via investment funds.
Over the long term the returns achieved by investing in stocks and shares will likely outperform what you can earn through cash savings.
Using the right investment strategy could mean significant returns over the years and the fact you will pay no tax at any point on these returns make this a fantastic product.
Interestingly you can now invest in Alternative Investment Market (AIM) shares through an ISA. These are shares in smaller, more riskier companies. However AIM shares are free from Inheritance Tax (IHT), so this is one way to ensure your ISA is IHT free.
A Stocks and Shares ISA is most suitable if you are investing for the long term and/or as an alternative retirement account to compliment your pension.
Lifetime ISA (LISA)
LISAs are fairly new on the ISA scene.
You can save up to £4,000 per year into a LISA and the government will top up your savings via a 25% bonus each year. You can open a LISA and other types of ISAs but the combined contribution in any one year cannot be more than £20,000.
You must be over 18 and under 40 to open a LISA.
LISAs have two uses.
- Saving for your first home. You can withdraw the funds anytime from the LISA including the government bonus to purchase your first home.
- Saving for retirement. If you don’t use the funds to purchase your first home, then they cannot be withdrawn without penalty until you are 60 (this rule is currently relaxed and will be back in force from April 2021).
There are cash LISAs (for saving for first home) and stocks and shares LISAs (for saving for retirement) available.
Innovative Finance ISA
Another fairly new ISA on the scene.
You may have heard of Peer 2 Peer Lending whereby a digital platform will allow you to invest money which is then loaned out to multiple borrowers. The borrowers will pay you interest on the money you have loaned.
Previously the interest earned through this type of investment was subject to Income Tax. If you invest into this product through an Innovative ISA then any interest you earn is now tax free.
Investing into any Peer 2 Peer product should still be considered as an investment and therefore only done for long–term money. There can be times when Peer 2 Peer products have to suspend trading if there are too many people withdrawing funds at any one time.
Quirky rules to watch out for when selecting the best ISA
As the list of types of ISA grows, so do the rules which govern them, and this can throw up some quirky rules especially when it comes to mixing and matching them.
#1 – A couple can save/invest £40,000 per year into ISAs
ISAs are individual products; they can’t be opened jointly. But what this means is that if you are a couple you both get the £20,000 ISA allowance.
Say you have come into a large chunk of money, perhaps through an inheritance. By you both using your ISA allowances, each April you could soon have the money invested completely tax free for the rest of your lives.
#2 – Always transfer an ISA
From time to time it may make sense to move your ISA to a different provider. For cash ISAs it could be to get a better interest rate. For Stocks and Shares ISAs it could be to benefit from cheaper platform charges.
Whenever you move ISAs always TRANSFER the ISA, never take the money out and re-invest it with the new provider. If you cash it in it means you will have lost the build-up of previous years allowances and will be restricted to only putting in £20,000 into the new provider.
#3 – You can withdraw ISA funds temporarily
If your ISA provider operates a flexible ISA feature then it means you could take out some or all the money out of your ISA temporarily. As long as you put the money back in before the end of the tax year you took it out, it won’t impact your ISA allowance.
This could be useful for people who need access to temporary finance and know they have funds coming that will allow them to replenish the ISA.
#4 – You can save more than £20,000 for children
Once a child turns 16 they can open an adult cash ISA. Which means for 2 years you could still pay in £9,000 into their Junior ISA and £20,000 into their adult cash ISA.
#5 – ISAs are normally subject to IHT
Whilst ISAs are great during your lifetime, allowing you to earn and take out money tax free, they are not normally so good on death.
You could spend years of your life building up an investment portfolio, using your ISA allowance each year but then on death the whole lot could be subject to IHT at 40%.
The only way to avoid this is to invest into AIM shares however, this is a risky approach.
#6 – You can now inherit your spouse’s ISA
As usual the government have made this slightly more complex than it needs to be.
If your spouse or civil partner dies leaving ISAs, then your ISA allowance for one tax year will be the normal £20,000 plus the equivalent value of your deceased partners ISA value at date of death. Meaning you can keep further funds tax free.
This needs to be claimed though and won’t happen automatically. The new combined ISA could still be subject to IHT on your death. See point 5 above.
If you would like assistance selecting the best ISA option for you then please secure a free 15-minute call. You can speak to a Chartered Financial Planner who will listen to your situation, give you an outline of what you need to consider and guide you in the right direction.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
