Individual Savings Accounts (ISAs): the Rules, the Types

Posted on March 14, 2020

Updated April 2020 to reflect current tax allowances and interest rates

If you’re interested in putting money aside – for emergencies, for specific life events, or just as a non-specific ‘nest egg’ – then you should be aware of ISAs (Individual Savings Accounts).

These are government-legislated ‘wrappers’ designed to protect their contents from tax.

ISA Income Tax Benefits

Everyone has a Personal Savings Allowance: the amount of interest they are allowed to keep before Income Tax will be assessed on the remainder. Interest paid within an ISA is exempt from this assessment. Anyone investing via shares has a Dividend Allowance: the amount of dividend payments from the company that issued the shares they are allowed to keep before Income Tax is assessed on the remainder. ISAs are also exempt from this assessment.

ISAs do not have to be included in your annual tax return, simplifying your personal financial administration (or lowering your accountancy costs, if you outsource this particular headache).

ISA Capital Gains Tax Benefits

Capital Gains Tax is due in many different circumstances: investors are, hopefully, aware that it is due on any increase in the value of shares, unit trusts, and some types of bonds. ISAs are exempt from CGT assessment, a benefit that is perhaps not immediately apparent to fledgling investors when the (2020/21) CGT threshold is £12,300. But investing is best considered a long-term activity and – depending on the assets held and their performance – a portfolio built up over many years could see large increases in its value within the space of a year. If this happens within an ISA then that ‘win’ is yours to keep.

General ISA Allowances & Rules

The amount of cash that can be saved, or invested, is set every year by the government. For the 2020/21 tax year the allowance is £20,000. Any unused allowance expires at the end of the tax year and cannot be carried forward. In the past the rules about exactly which types of ISA an individual could hold at the same time were more complicated; however in mid-2015 things were simplified to a large extent. Currently it is possible to list the restrictions as follows:

  • your allowance can be split as you wish between four of the six types of ISA (we’ve listed these below);
  • Junior ISAs have their own separate annual allowance;
  • the Help to Buy ISA has a maximum annual despoit of £2,400 (£3,400 in the first year) and a maximum deposited in all of £12,000;
  • the Lifetime ISA has a maximum annual deposit of £4,000.

Do be aware that, whilst ISA allowances and bonuses are government policy, ISAs are not provided by the government but by banks, building societies and other financial institutions. It is important to understand that ISAs are products in a marketplace, albeit one regulated by the Financial Conduct Authority. As with all products, there are ones that are better (or just more suited to your individual circumstances) and ones that are worse (or less suitable for you).

Types of ISA

At time of writing there are six different types of ISA. You must be at least eighteen years old for all but the Cash ISA, and you must live in the UK (or be employed by the Crown).

Cash ISA

Available once you are aged 16, the Cash ISA is basically a savings account – with one significant difference. With a normal savings account, interest payments in excess of an individual’s Personal Savings Allowance would be taxed. Basic rate payers have a £1,000 allowance and are taxed at 20% above that; higher rate payers have a £500 allowance and are taxed at 40% above that; and additional rate payers have no allowance and are taxed at 45% on all savings. A Cash ISA is exempt from tax on interest, no matter the amount – and interest payments are not counted as part of the individual’s Personal Savings Allowance either.

Depending on the provider, you might be required to deposit a lump sum or a minimum monthly amount; you might have instant access to your money or have your withdrawals subject to a notice period or a fixed term. However, all Cash ISAs should be free to open.

The best interest rates offered by Cash ISA providers continue to tumble. You’ll get just 1.05% over one year (and you can get rates close to that on non-ISA accounts which might have less restrictions on withdrawals). Even if you lock your money away for five years, 1.3% is the best rate available.

In an environment where interest offered on savings is so pitifully low, it is not surprising that more and more people are looking to see if they can generate more attractive returns from investments, which is where a Stocks & Shares ISA comes in.

Stocks & Shares ISA

If you’re prepared to lock your money away for longer, and also prepared to entertain the risk of losing it, then you might want to consider a Stocks & Shares ISA. They can be used to hold bonds (both government and corporate), direct shareholdings, collective investments via managed funds (both Open-Ended Investment Companies and Investment Trusts), Unit Trusts, or a mixture of all of these.

Generally a five year minimum term is recommended, not least to smooth out any swings in the cash value of your portfolio. However if you’re prepared to lock your money away for considerably longer periods then it is possible (although not guaranteed) to achieve impressive returns. The FT reported earlier this year that, according to brokers Hargreaves Lansdown, 250 people had ISA portfolios valued at £1 million or more, with many more people holding equities with high six-figure valuations.

There is no Capital Gains Tax on any profit made through a rise in the value of your portfolio (e.g. a share price increases), nor is there any Income Tax on any dividends or other returns. But do remember:

  • the ISA wrapper confers no special status on your investments, which will each have their own risk characteristics and potential yields;
  • some providers charge fees to open the account and to change investments or move to a different provider.

For those seeking enhanced returns via investment, the well-worn mantra bears repeating: the value of your investment can go down as well as up. This is not the same as taking an unacceptable amount of risk. Some assets are very much more conservative than others, and a competent financial planner will ensure that you are invested in accordance with your appetite for risk – or lack of it.

Find out more about Stocks & Shares ISAs here.

Junior (Stocks & Shares) ISA

Introduced in November 2011, these replaced Child Trust Funds as a means of creating a ‘coming of age’ gift for a young person. They can be set up by parents or guardians (but paid into by anyone) on behalf of those who are under eighteen and accessed by the ‘beneficiary’ from their eighteenth birthday. They enjoy similar tax advantages to standard ISAs, and there is also a Stocks & Shares option. There is a separate annual Junior ISA allowance (which shot up dramatically from £4,368 in 2019/20 to £9,000 in 2020/21) and this can be divided between the two types of accounts.

Find out more about Junior ISAs here.

Innovative Finance ISAs (IFISA)

A new vehicle, created in April 2016, this holds investments made via ‘P2P Lending’ (Peer to Peer, also called Crowd Lending) platforms. The term ‘mixed bag’ is apt here: an IFISA could very well hold unsecured personal loans that have been made to borrowers who have been declined finance by banks. Whilst P2P Lending is regulated by the FCA in the UK, and the UK’s very first P2P lender posted a ‘bad loan’ ratio of less than 1% in their first seven years from 2005, loans made more recently via platforms that entertain less credit-worthy borrowers have resulted in astronomical default rates (up to 70% in some countries) and P2P lending is generally regarded as a high risk investment.

Help to Buy ISA

Intended to help potential first-time buyers build up that much needed but often hard to find mortgage deposit, the Help To Buy ISA includes a government contribution to help people get their foot on the property ladder. For every £200 invested, the government adds a bonus of £50, up to the maximum of £3,000 on £12,000 saved.

There are restrictions: the property a mortgage is sought on must be valued at under £250,000 outside London or £450,000 inside London. But the Help to Buy ISA is connected to an individual, not a property, so a couple looking to buy together could pool their resources and get £6,000 towards their deposit under this scheme.

New Help to Buy ISA accounts could only be opened up until midnight on 30 November 2019. The scheme has been replaced by the Lifetime ISA.

Lifetime ISA

Successor to the Help to Buy ISA and more besides, the ‘LISA’ is available to those aged 18-39. Deposits made into a LISA attract the same 25% government bonus as the Help to Buy ISA, but you can earn a bonus of up to £32,000 instead of £3,000. If you deposit the maximum allowed of £4,000 every year, you will receive the maximum bonus of £1,000 per year, every year until you are 50 years old, when the account is frozen until you are 60 years old.

You can use a Lifetime ISA to hold cash, or investments, or both. There are financial penalties for early withdrawals unless you are using the withdrawal to fund the purchase of your first home via a mortgage.

Find out more about Lifetime ISAs here.

INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS, WHICH ARE SUBJECT TO CHANGE. THE TAX BENEFITS RELATING TO ISA INVESTMENTS MAY NOT BE MAINTAINED.

STOCKS & SHARES ISA INVESTMENTS DO NOT INCLUDE THE SAME SECURITY OF CAPITAL THAT IS AFFORDED WITH A CASH ISA. THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED. PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.

No guarantee can be given that the information provided is accurate in the present or the future. It is not intended to constitute either a statement of applicable law or financial advice, and responsibility cannot be accepted for any subsequent loss following activity or inactivity by any individual or organisation. Indeed, such information should NOT be acted upon without first receiving appropriate and specific professional advice.