ISA Archives

ISA stands for individual savings account and is an investment vehicle that has great tax breaks. It allows you to earn interest on cash savings or dividends from investments without paying income tax or capital gains tax.

To ensure this tax break is not exploited, there is a restriction placed on how much you can pay into them each tax year.

How do they work?

Each tax year, which runs from 6 April to 5 April the following year, you have an ISA allowance. Currently the ISA allowance is £20,000 for this tax year. This means you have until 5 April to use your ISA allowance for this tax year.

Use it or lose it. If you miss the tax yearend deadline, you cannot back pay to catch up missed contributions. Any money you pay into an ISA will count towards your ISA allowance for the following year. This regularly catches people out with busy lives each year.

To be eligible to open an ISA, you need to:

Be 16 or older for a cash ISA
Be 18 for stocks and shares ISA
Be the parent or guardian of a child under 18 to open a Junior ISA
Be 18 to 39 to open a lifetime ISA
Be a resident in the UK (or a Crown employee if abroad)

An ISA can only be held in one person’s name. It’s not possible to have an ISA in joint names. Hence the title individual Savings Account.

There are two main types of ISA: cash ISAs and stocks and shares ISAs. There are also some specialist ISAs to choose from.

Cash ISAs

These are similar to regular bank / building society savings accounts with the advantage of a tax efficient wrapper. They should be used as short-term investments ie up to 5 years for maximum effect. Beyond this time scale inflation has the potential to reduce the value of the funds. There are two basic types of cash ISA:

Instant access: Allows you to withdraw and deposit funds in line with the provider’s terms.
Fixed term: Your money is wrapped up for set period of time during which you receive a fixed rate of interest but have no access. As the interest rates rise there are some very good rates on offer.

Stocks and Shares ISAs

These are stocks and shares investment accounts that use your ISA allowance as a wrapper to make them tax efficient. There are a huge variety on offer covering several investment styles and client attitudes to risk. This can make it very hard to compare apples with apples. Care should be taken also to ensure that any charging is made clear from the start.

As with most investment-based products your money is at risk as the value of stocks and shares can fluctuate. However over the longer term (5 years plus) you have the potential to receive better returns than say with Cash ISAs. These tend to form the basis of most investors portfolios as the starting point due to their tax efficiency.

Specialist ISAs

Junior ISAs: for under 18s only, limited up to £9,000 per annum currently. Can be Cash or Stocks and Shares based.
Lifetime ISA: for adults under 40 saving for retirement or to buy their first home. At a very high level they let you earn a 25% bonus on savings up to £4,000 a year. Care and advice should be taken because although you can access the funds whenever you like. You only get the bonus if you use the cash to either buy your first home or take it out after you turn 60. If you withdraw the money for any other reason, you will lose 25% of it as the government takes its money back plus a little extra.
Innovative finance ISA: Peer-to-peer investments which earn interest by lending money to individuals, businesses and property developers. These usually require financial advice to be taken to ensure suitability.
Business Property Relief (BPR) based ISAs: ISAs are not totally tax free; they are liable to Inheritance Tax upon death. Using an ISA that can take advantage of BPR can help ringfence funds from inheritance tax. These tend to be higher risk options and should be discussed with an IFA before proceeding.

You can open a Cash ISA either in a bank/building society branch, online, by post or over the phone, depending on the type of account and provider you choose.

Investment ISAs are similar but best taken out via an Independent Financial Adviser who can source the right plan for your circumstances. They should also ensure that the scheme is covered by the Financial Conduct Authority and the Financial Services Compensation Scheme. They will also explain the risk level and ensure that you do not over commit too much of your hard-earned funds in one go. For some Cash ISAs you can start with as little as £1. For investment ISAs this tends to be higher for lump sum investments. A regular premium amount typically start around £50 pm. There is no right amount to start with. It will depend on your own situation. Always ensure that you have enough hands on cash available to cover emergencies. As a guide this is typically 3 – 6 months of expenditure. You will also need to supply your National Insurance number. Always read the small print before signing to ensure that you understand what you are investing into.

How many ISAs can you have?

You can build up several ISAs over the years. You can consolidate your past ISAs by transferring them to your current ISAs if they offer better terms.

You can only pay into one cash ISA, one stocks and shares ISA, one lifetime ISA and one innovative finance ISA in each tax year, and the total you invest across the types of account must not exceed your ISA allowance – currently £20,000.

You can transfer to a new ISA within a tax year – but only if you take all the money you’ve already saved into the old ISA to your new one.

If you have opened a junior ISA for a child, this is not included in your £20,000 allowance (it’s the child’s allowance, which is £9,000 a year currently).

Can you withdraw money from your ISA and put the money back later?

This depends on the terms and conditions of your ISA, so ensure you find out before opening a new ISA whether:

Your ISA is flexible

You can withdraw money and pay it back in during the same tax year without it affecting your ISA allowance (eg if you deposit £10,000 then withdraw the same amount, you can still pay in a total of £20,000 this tax year)
You can also withdraw any ISA money you have from previous tax years, and have until the end of the tax year to pay it back into the same ISA.

Always, check the small print before doing anything as some ISAs may limit the number of transactions you can make in a year. Not all providers allow transfers either, you should also check the T&Cs before making a withdrawal.

Your ISA is not flexible

Any money you pay in then withdraw, still counts towards your remaining ISA allowance (eg if you pay in then withdraw £5,000, you can only deposit up to £15,000 for the rest of this tax year).
Deposits that exceed the allowance will be rejected

Once taken out of an ISA your money will lose its tax-free status if you pay it into a normal savings account.

Can you transfer an ISA to another ISA?

You may want to move holdings in a previous year’s ISA to a new one if the rate of return or fees are more competitive.

This is allowed under the rules; just don’t attempt a transfer until you’ve checked whether your new ISA allows transfers in.

To retain your tax advantages, you need to transfer your ISA directly from one provider to another.

However, if you try to move your ISA by withdrawing the funds, you will lose its ISA status, as it’s no longer within the tax-free wrapper. You may find that a lifetime of tax efficient savings is lost by making this common mistake.

What happens to your ISA upon the death of the plan holder?

Upon death an ISA becomes part of your estate and loses its tax-free status, meaning it’s liable to income tax.

The exception is if you leave behind a spouse or civil partner. Then they would see an amount equivalent to your ISA added to their current year’s allowance, tax-free.

E.g. you pass on leaving £20,000, your spouse or civil partner would receive a one-off addition to their own ISA annual allowance of this sum, giving them a total allowance of £40,000 to invest.

Even if you leave your ISA to somebody else in your will, your spouse or civil partner will still gain the £20,000 additional ISA allowance.

What protection does your ISA have?

The Financial Services Compensation Scheme (FSCS) protects the first £85,000 of any cash or investments held in ISAs with each separately registered institution.

To qualify, your ISAs must be in a financial company, such as a bank or investment house, that’s regulated by the Financial Conduct Authority.

CARE, if you have more than £85,000 in savings with one institution, or two separate companies within the same group, you could end up out of pocket should the group go under as the FSCS only guarantees a payout of £85,000.

The above should be viewed as impartial guidance as to ISA options and what they might mean. The final decision to invest would be yours but as with any investment, if it’s not an area you are completely familiar with you should seek Independent Financial Advice.

This material is intended to be for information purposes only and is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Past performance is not a reliable indicator of future returns and all investments involve risks. Some information quoted was obtained from external sources we consider to be reliable.

Tees is a trading name of Tees Financial Limited which is authorised and regulated by the Financial Conduct Authority. Registered number 211314. Tees Financial Limited is registered in England and Wales. Registered number 4342506.

Measure inflation

A good way of understanding how a price index works is to think of an extremely large shopping basket containing a mix of the various goods and services a typical household buys – the price index basically shows changes to the overall cost of that basket over time. For the CPI, prices for around 700 things people regularly buy are recorded each month. These cover a variety of items including a loaf of bread and ready-meals, the cost of a cinema ticket and a pint at the local pub, as well as larger items such as a holiday and a car. To calculate the index, ONS compares the current cost of the basket with what it was a year ago – the change in price level is the annual rate of inflation.

The impact of high inflation

A healthy economy generally requires inflation to be low and stable. While a small amount of inflation is considered helpful, high and unstable rates can cause extreme economic difficulties as it erodes the purchasing power of household finances and makes it difficult for people to plan how much they can spend, save or invest. In the UK, the government has a 2% target for how much prices should go up each year with the Bank of England tasked with keeping the figure around that level. The Bank’s principal tool for maintaining a low and stable inflation rate is to raise or lower interest rates.

Interest rates and inflation

Economic theory shows there is an ‘inverse’ relationship between inflation and interest rates: in other words, when interest rates are low inflation tends to rise, and when rates are high inflation tends to fall. This is because high interest rates make it more expensive for people to borrow money and encourages them to save, which means they typically spend less on goods and services, and this results in prices rising more slowly; and vice versa. So if prices are deemed to be increasing too rapidly, the Bank of England will typically raise interest rates in order to try to slow inflation down.

Purchasing power

When the rate of inflation is low, its impact can seem relatively modest, but when inflation is high it can drastically erode the purchasing power of money. For example, if the rate of inflation is 1%, then the price of a loaf of bread that cost £1 a year ago would now be £1.01. However, if inflation is running at 10%, the price of the same loaf would rise to £1.10. In other words, households can buy less for the same amount of money or, to put it another way, money has effectively lost value.

shopping carts

Inflation makes things more expensive over time.

Impact on savings

Inflation has a similar devaluing effect on deposit-based savings balances. For instance, a saver who held £10,000 in a building society account a year ago earning a rate of 1%, would receive £100 in interest and thereby see their total balance rise to £10,100. However, if inflation was running at 10% then the same £10,000 worth of goods and services that could have been bought a year earlier would now cost £11,000. So, although the saver may feel they have earned £100, when factoring in the effects of inflation, the value of their cash savings has actually declined by £900 in real terms.

Investment potential

While cash savings will always be important, particularly as a source of rainy-day funds, in the current economic climate people holding a large proportion of their assets in cash look set to lose money in real terms. For anyone planning to put money aside for a number of years, it may therefore be worth considering investments as a potential way to protect capital from the effects of inflation. Although past performance is no guarantee of future profits, stock market investments have tended to produce returns that could potentially inflation-proof money over the longer term, providing savers are prepared to take some degree of risk.

Tax-efficient investments

As well as potentially offering protection from inflation, some investment products also enjoy significant tax advantages that make them particularly attractive investment propositions. Both pensions and stocks and shares ISAs fall within this category.

Pensions

Investing via a pension is one of the most tax-efficient methods of saving for the long term as investors receive tax relief at their highest marginal rate of Income Tax on all contributions made subject to annual and lifetime allowances. This means that some of your earnings which would have gone to the government as tax are instead diverted to boost your pension pot. This effectively results in it costing you less to save more in a pension plan.

Stocks and shares ISAs

Individual Savings Accounts (ISAs) are another tax-efficient investment option and provide greater flexibility than a pension as they allow access to your money before the age of 55. Investors can save up to £20,000 each tax year in a stocks and shares ISA with the money having the potential to grow free of UK Income Tax and Capital Gains Tax. These products can be a particularly good way to save for medium or long-term financial goals, such as a wedding or new car.

real growth

This graph shows the effect of a 2% inflation rate on £100 over a 40-year period with cash assumed to earn no interest – maybe kept under your mattress! A growth rate of 7% per annum is assumed for equities but is for illustrative purposes only and not an indication of future performance. After 40 years, the initial £100 can only buy goods that would be worth just under £45 at today’s prices, compared to an equity investment which would have the purchasing power of £704.

growth of 1 pound

Obviously, very few of us would keep cash under the mattress, but even with cash deposits earning 1% a year, £1 would only be worth £1.49 after 40 years if held in cash, or over 10 times that amount if invested in equities, assuming a growth rate of 7% p.a.