Use it or lose it: Why it’s still important to hold an ISA
The Individual Savings Account (ISA) has become common place for even the novice saver or investor and is often the first port of call when you look to begin saving or tax planning.
What is an ISA?
An ISA is simply the tax-efficient wrapper that can house the cash or investments inside an account. This means the cash or investment (stocks and shares) inside the ISA can grow free of income or Capital Gains Tax (CGT) and any money saved or withdrawn is tax free. Sounds too good to be true? Well in short it is, which is why the government sets limits on how much you can contribute in each tax year. In the 2021/22 Tax Year you can contribute up to £20,000, and this amount has been frozen at this level until 2026.
When is an ISA the right choice?
ISAs can provide a suitable solution for a variety of individual needs. Saving money for your first house purchase but aren’t impressed by the current rates offered by your bank, well a Lifetime ISA (LISA) could be for you. Saving for retirement and would like an additional pot to draw from alongside your pension, well a Stocks and Shares ISA could be for you or indeed a Lifetime ISA. Unsure about the idea of investing in the stock market but would like your interest to be tax free, well a Cash ISA might prove a wise choice.
But with so many options, how do the different types of ISAs fit in with your financial plan and objectives? Here we explain some of the options.
You can open a Cash ISA from the age of 16. The account is like a bank or building society savings account, but all interest earned from your deposit will be tax free. The interest rate you receive can be fixed or variable depending on the type of Cash ISA you choose.
For some savers having ease of access to cash is a priority and a Cash ISA can provide instant access to capital whenever it is needed, provided you choose the right one. So, whether there is a short-term expense need or you just fancy earmarking that rainy day fund, a Cash ISA might prove useful.
'The introduction of the Personal Savings Allowance (PSA) in 2016 has somewhat diminished the tax benefits of the Cash ISA.'
The introduction of the Personal Savings Allowance (PSA) in 2016 has somewhat diminished the tax benefits of the Cash ISA. As a basic rate taxpayer, you can now earn up to £1,000 tax free in any savings account, reduced to £500 for a higher rate taxpayer. This has meant that for most people the interest they receive on their deposits will fall within these limits and are therefore tax free - for now, at least with interest rates so low. Once interest rates begin to rise then this makes the PSA less valuable of course.
It's worth noting that additional rate taxpayers do not qualify for the PSA so to them, the Cash ISA could still be a good option.
Stocks and Shares ISA
Anyone over the age of 18 can open a Stocks and Shares ISA. Your money is invested, and so offers the potential for higher returns when compared to the Cash ISA. This however is not without its risks; you will need to be prepared to lock your money up for a longer timeframe, be comfortable that the investments can go up as well as down and be prepared that charges will impact performance.
With the Stocks and Shares ISA it is normally a long-term game, where you need to give the investment time to grow and ride any short-term ups and downs. Investing on a regular basis can also mean that you could benefit from what is known as pound cost averaging, whereby your investment buys units at different times in the market which smooths out possible volatility.
The Stocks and Shares ISA could provide you with a useful pot of tax-free money for retirement or provide a vehicle in which you can start to save for your child's future. Whatever the goal, it is important you speak with your adviser on whether this is the most suitable solution for you.
Lifetime ISA (LISA)
Lifetime ISAs are the newest ISA on the block, launched in 2017 and designed to offer first time buyers some much needed help getting on the housing ladder. They can also be used to build a tax-free retirement fund that you can access when you are 60.
You must be aged 18-39 to open a Lifetime ISA and you can invest up to £4,000 each tax year until you are 50. It is worth noting that if you open a LISA you would only have £16,000 left of your overall ISA allowance for other types of ISAs.
The biggest advantage of the Lifetime ISA is that you receive a 25% Government bonus for each contribution made, meaning a contribution of £4,000 will receive a bonus of £1,000 taking it up to £5,000. This generous bonus makes them very popular, especially when you compare this to the current low rates being paid to savers.
The LISA comes in two forms, cash and stocks and shares. The suitability of each relies on the timeframe you’re looking to save for and your attitude to investment risk.
So, if you are looking for a leg up onto the property ladder and buying in under 5 years and wouldn’t be comfortable with investment risk, a cash LISA can provide the security and ease of access you need. On the other hand, a stocks and shares LISA might be useful to accumulate a tax-free pot for retirement.
Be warned if you withdraw funds from your LISA that isn’t for your first home or before you turn 60, you face a penalty of 20%.
Junior ISA (JISA)
And last but by no means least is the Junior ISA. Just like the adult version in terms of the tax benefits but instead of saving for your own future you can save for your children’s.
Again, similar to the LISA a JISA can be cash or stocks and shares in order to suit to your individual preferences and savings goal.
You can save up to £9,000 a year into a JISA which is completely separate to your own ISA allowance of £20,000.
Let's look at an example:
John and Susan have 3 children, Lindsey and Zach are 14 and Megan who is 16, how much could the family contribute to an ISA in one tax year?
|Family Member||ISA contribution|
|Megan||£9,000 + £20,000|
Because Megan is 16, she could open her own Cash ISA and her parents could still contribute her full JISA allowance.
The real value is in the tax planning – here's how TPO can help
The humble ISA can offer fantastic opportunities for tax planning, including pensions and inheritance tax planning, both on an individual and family basis. The ISA landscape has evolved over the years and the variety of choice can often mean that it is difficult to decide which one or mix of ISAs best suit your individual needs.
For this reason, it can be important to seek professional advice in navigating this landscape to provide you with solutions best suited to your financial plan.
Tax and its legislation continually evolve which is exactly why we’re at the forefront of these changes to guide you through the complexity. If left alone, financial plans can quickly become unsuitable as tax rates are increased, reliefs reduced, and eligibility criteria tightened.
If you are keen to find out more about how an ISA fits into your financial plan and how we can add value, please get in contact. We’re currently offering everyone with £100,000 or more in savings, investments or pensions a free consultation.
Please note: Investment returns are not guaranteed and you may get back less than originally invested. This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.