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Guide to Individual Saving Accounts (ISAs)
What is an ISA?
Any individual, who is an income tax payer and has some money to save or invest, should know about Individual Savings Accounts (ISAs). Available since April 1999, ISAs offer an attractive tax-favoured shelter to anyone aged 18 or over (16 or over for cash ISAs).
With standard bank and building society savings accounts taxpayers normally have to pay tax on any interest earned on their money in excess of any personal allowance. Similarly, tax must be paid on the income and profits made from investments in the stock market, like company shares or unit trusts.
ISAs serve as a kind of ‘wrapper’ to protect savings from tax, allowing individuals to invest monies (by way of regular or single amounts) up to maximum limits each tax year in a range of savings and investments and pay no personal tax at all on the income and/or profits received.
The Main ISA Benefits
- No personal tax (income or capital gains) on any investments within an ISA.
- Income and gains from ISAs do not need to be included in tax returns.
- Money can be paid or withdrawn at any time without losing the tax breaks.
ISA Maximum Contribution Limits
The current ISA overall maximum contribution limit is £20,000 for the 2019/20 tax year.
The Basics of How ISAs Work
There are five types of ISA:
- Stocks and Shares: in the form of either individual shares, bonds, or pooled investments (such as open-ended investment funds, investment trusts, or life assurance investments).
- Cash: usually containing a bank or building society savings account.
- Innovative Finance (IF-ISA): in the form of loans made through peer-to-peer (P2P) platforms
- Lifetime ISA (LISA): for those aged between 18 and 40; designed to help them save up for their first home or retirement. The maximum payable into a Lifetime ISA is £4,000.
- Help to Buy: aimed at helping first time buyers to save for their mortgage deposit. Available until 30th November 2019. It is not possible to subscribe to both a Cash and a Help to Buy ISA in the same tax year.
You are able to open one Cash ISA and one Stocks and Shares ISA each tax year. You can also subscribe to an Innovative Finance ISA, Help to Buy ISA, or Lifetime ISA. The amount of new money paid into all ISAs held by you must not exceed the overall ISA contribution limit for the relevant year.
Cash or Stocks and Shares ISAs can be transferred; both between providers and between types (Cash to Stocks and Shares and vice versa) an unlimited number of times.
An ISA is not a risk free product and the value of the ISA investment may be at risk due to the investments held within the wrapper.
Innovative Finance ISAs (IF-ISAs) were launched on 6th April 2016 to increase the choice and flexibility available to ISA investors, encourage the growth of peer-to-peer (P2P) lending and improve competition by diversifying the available sources of finance. Please note, it may not be possible to sell or trade P2P agreements at market value on a secondary market. There is no protection available under the Financial Services Compensation Scheme (FSCS) in the event that the P2P Platform operator fails. Innovative Finance ISAs cannot be transferred to other ISA wrappers, however it is possible to transfer existing ISA funds into IF-ISA.
Help to Buy ISAs came into force in December 2015 and provide 25% tax relief on savings up to £12,000 to add to a first time buyer’s house deposit. The tax relief is given on purchase of the home. These are Cash ISAs and the savings are limited to a maximum initial deposit of £1,000 and regular monthly savings of £200. Property values can’t exceed £250,000 (£450,000 in London). These are available until 30th November 2019. It is not possible to subscribe to both a Cash and a Help to Buy ISA in the same tax year.The Lifetime ISA was introduced on the 6th April 2017 for individuals under the age of 40. You have the ability to subscribe £4,000 a year and receive a 25% government bonus at the end of each tax year on the subscriptions made prior to age 50. Higher subscription limits can be made but no bonus will be payable. These funds can be drawn on, tax free, to purchase a home with a value of £450,000, at age 60, or if you are terminally ill. Should the capital be withdrawn prior to the above there will be a 5% charge and the bonus will be lost. A LISA will form part of your estate under Inheritance Tax rules. LISA contributions will count towards your total ISA allowance for the tax year.
Stakeholder Standard ISAs
There is also a Stakeholder Standard ISA which meets the Government’s guidelines regarding cost, access, and terms. Cash and Stocks and Shares ISAs can qualify for a Stakeholder Standard. The cost limit varies with each investment type and the access and terms criteria specify that investors must be able to get their money back at any time, without penalty and with no other restrictions. The ISA must also offer low minimum investment limits and can only invest a maximum of 60% in global equities and property, with the remaining 40% in less volatile assets such as bonds and cash.
Because of these limits, Stakeholder Standard Stocks and Shares ISAs are designed to meet the needs of a wide range of investors. For this reason, they may be less appealing to experienced investors who want to maximise their long-term growth potential and are therefore more likely to seek specialist funds.The presence or absence of a Stakeholder Standard cannot predict whether an ISA will prove to be a good or bad investment. A Stakeholder Standard ISA has not received Government approval of any kind, nor is your money or investment return guaranteed by the Government in any way.
Any investment returns received will be tax-free.
Income generated from investments held in ISAs is variable, tax free and is not guaranteed.
Any withdrawals from ISA are also free of tax.
On death, the value of your ISAs will be included in your estate for Inheritance Tax purposes.
If an ISA saver in a marriage or civil partnership dies, their surviving spouse or civil partner will inherit their ISA tax advantages. The surviving spouse will be able to invest as much into their own ISA as their spouse had invested, on top of their usual allowance. In other words, the government will allow an additional ISA allowance for spouses or civil partners, when an ISA saver dies, that is equal to the value of the saver’s ISA holdings on their date of death. Thus, allowing the surviving spouse or civil partner to transfer the ISA into their name.
So, if an ISA holder were to die, leaving an ISA valued at £30,000 at the date of their death, their spouse/civil partner is entitled to an additional ISA allowance of £30,000. Where a cash subscription is paid, the spouse/civil partner has 3 years from the date of death to use this, or if later, 180 days from the completion of the administration of the estate, and it can be paid in addition to their ISA allowance.
Where the ISA assets are left to someone else in the Will, or are used to meet expenses from the estate, the spouse/civil partner is still entitled to the additional allowance and this cannot be claimed by anyone else, even if they receive assets from the ISA.
If there is no surviving spouse ISAs stop being tax free when the first of the following occurs:
• The administration of the estate is completed
• The account is closed
• Three years after death
To be eligible to invest in an ISA, an investor must be an individual (i.e. not a company or trustee) who is 18 years of age or over (except that 16 and 17 year olds are able to invest up to £20,000 in a Cash ISA) and who is resident and ordinarily resident in the UK (or is a Crown servant serving overseas or the spouse of such an individual who accompanies their spouse abroad).
When an individual ceases to be eligible to invest in a ISA, any existing ISAs will continue to be exempt from UK tax, but future contributions to regular investment ISAs must be terminated and no further single contributions may be made.
Each individual may effect a Stocks and Shares and/or Cash ISA each tax year (subject to prescribed limits). A husband and wife are treated as separate individuals so that although joint ownership of an ISA is prohibited each may fully subscribe to ISAs in their own name.
Bed and ISA
A bed and ISA is where an investment is sold and then bought back within an ISA. The two transactions are carried out together so there is less exposure to market movement. However, the amount of shares bought in the ISA may be less than the amount of shares sold in the dealing account due to the costs deducted, for example; stamp duty, dealing charges, and the difference between the market buying and selling price.
Under HM Revenue and Customs regulations, you cannot transfer your existing investment straight into an ISA as stock. Instead, you need to sell your shares and reinvest the sale proceeds into your choice of ISA funds.
You should note that your investment will be out of the market between the sale of your existing funds and the purchase of your new funds.
HM Revenue and Customs will treat this as a new ISA investment, so it counts as part of your ISA allowance for the relevant tax year.
Where the original investment is held in an OEIC/Unit Trust, the investments/funds will need to be sold and then repurchased by the ISA manager. The sale of your existing funds will count as a disposal for Capital Gains Tax (CGT) purposes. When the sale proceeds are reinvested in full, any CGT liability will have to be met from other resources.