Top 5 things you need to know about ISAs

In this handy guide, we explain how ISAs could form an important part of your retirement plan.

You spend your life working hard to make money, but if you want the best possible retirement plan you also need to make your money work hard for you. The power of inflation means any savings kept in cash lose value over time, and quite painfully so when inflation is in double digits as it has been recently. It’s wise, therefore, to make money on your savings either by putting it into an account that pays interest on it or by investing it in assets which, hopefully, will grow in value.

The downside is all interest, income or capital gains from savings and investments are liable for tax charges, beyond the allowances available to you each year. Basic-rate taxpayers can earn up to £1,000 interest annually without needing to pay tax on it, while higher-rate taxpayers get £500 (additional-rate taxpayers enjoy no such allowance). All taxpayers get a £2,000 annual allowance on investment income from dividends, though this will reduce to £1,000 in the next tax year and then again to only £500 in 2024. Finally, we all have an annual capital gains tax allowance of £12,300, but this reduces to £6,000 this April and then just £3,000 from April 2024.

Tax charges on your savings and investments can deplete funds held for retirement, and the annual allowances which exist to protect your hard-earned money will be so slim from 2024 that individual savings accounts, or ISAs, will be more important than ever. An ISA is effectively a tax-efficient wrapper around your savings and investments, enabling you to make money on your money without having to declare it on your tax return. In this handy guide, we outline five important things you ought to know about ISAs – and how you can make the most out of them.

£20,000 annual limit – use it or lose it

Each tax year, which runs from 6th April to 5th April, every adult in the UK is able to contribute up to £20,000 into up to two ISAs. Once inside the ISA wrapper, your savings and investments can grow entirely tax-free, and when you decide to withdraw funds you can do so without having to pay any income, dividend or capital gains taxes. You don’t even have to tell the taxman. Over a lifetime this could save you many thousands in tax. Remember, however, that the annual ISA contribution limit can’t be carried forward. Use it within the tax year or lose it.

Control your risk (and potential returns)

The two main kinds of ISAs are cash ISAs and stocks and shares ISAs, and what you opt for will very much depend on your appetite for risk and returns. If you’re uncomfortable with risk, a cash ISA will offer a guaranteed amount of interest, which is also attractive if you have a fairly short-term savings goal, such as buying a car. However, given inflation is quite substantially higher than the best cash ISAs on offer right now, and some normal savings accounts outside an ISA wrapper offer more interest, there are currently few instances where this is a great idea.

A stocks and shares ISA can potentially offer much greater returns, but there is also more risk given you are at the mercy of markets out of your control, meaning your investments could in fact go down. This is why it’s best to take a long-term approach to such investments, giving you the time to see through peaks and troughs. With this kind of ISA you can be hands on or hands off, and make selections based on your risk appetite, but bear in mind that depending on how much work you take on yourself in managing your investments there will be various fees to pay.

Mix and match?

The rules surrounding ISAs and what you can do with them can be quite complex, so it would be valuable to engage with an Independent Financial Adviser to ensure you follow the rules correctly. For instance, you can hold multiple ISAs at the same time but you can’t pay into more than one of the same kind in the same tax year (e.g. you can open and pay into a cash ISA and stocks and shares ISA in one tax year, but not two cash ISAs or two stocks and shares ISAs). Meanwhile, there are no limits on ISA transfers – moving money from one to another – but only if you tell your new provider to facilitate the transfer. Do it yourself and lose the tax advantage.

Help your kids

There are two further kinds of ISA which offer interesting ways to help out your children or grandchildren, should that be a priority for you. Parents can open a Junior ISA for a child under the age of 18 and contribute, along with any friends or other family, up to a maximum of £9,000 each tax year, without impacting their own £20,000 annual ISA allowance. Like adult ISAs, junior ISAs can be a combination of cash ISAs and stocks and shares ISAs. The money can’t be withdrawn until the child turns 18, though beware they are then free to spend it as they please!

If you’d prefer to save into an ISA for your children with more restrictions over how they can access and spend the money, a Lifetime ISA could be a better option. It can be opened for anybody over 18 or under 40 and a maximum of £4,000 can be contributed each tax year. The Lifetime ISA also comes with an additional benefit which no other ISA offers: however much is contributed each year, the government will top it up by 25%. The catch? The money cannot be accessed before the recipient turns 60, unless for the specific reason of purchasing their first home. If money is withdrawn from the ISA for any other reason, it will trigger a 25% tax penalty.

ISA vs pension – which is best?

ISAs and pension schemes both offer tax-free vehicles to save and invest your money, so determining which one is best for you can be complicated. Both exempt you from paying tax on capital gains and income received on investments. But elsewhere their tax treatment differs.

One of the biggest benefits of a personal pension is you receive tax relief on what you pay in, based on your marginal rate of tax. No such relief is given on payments into an ISA. Likewise, funds within an ISA don’t enjoy the same exemption from inheritance tax as those in a pension.

Where ISAs do trump pension schemes, however, is in their limitless lifetime allowance, albeit with the £20,000 annual cap. The annual cap for tax-free contributions into a personal pension is higher (£40,000) but a lifetime allowance applies, currently £1,073,100. Perhaps the biggest benefit of ISAs is there is no tax to pay on accessing funds, whereas all withdrawals beyond the first 25% taken from your pension are liable for income tax. There are also no restrictions on when you can access ISA savings, while with pensions you must wait until you are at least 55.

The differing rules surrounding ISAs and pensions can make it complicated to understand which is best for you. An Independent Financial Adviser can assess your personal circumstances to understand how they can best meet your financial goals. It could well be a combination of both.

ISAs are a great way to save and invest invest but but getting on the wrong side of the rules could cost you money. An Independent Financial Adviser will assess your circumstances to identify how ISAs can help you meet your financial goals. Book a callback or speak to your Ascot Lloyd Financial Adviser to get started.