Individual Savings Account ISA: Make Tax-Free Income?
What Is An Individual Savings Account?
ISA stands for Individual Savings Account. ISA’s provide a tax-efficient way of saving or investing because the interest or gains on them are tax-free. Setting up a savings account is rather straightforward as UK residents of age 16 or over can have an ISA opened in their name. However, you would need a guardian to set up one for you if you are younger than 18 years of age.
An ISA account allows you to save up to £20,000 a year, which does not roll over into the next, so you should try and fill in most of the available allowance. When setting up an ISA you are presented with multiple options for what kind of account you would like to set up. You can save in cash, stocks, and shares, or a lifetime ISA, all of which have different rules and regulations. Additionally, you can withdraw money after satisfying the required conditions.
There are five main types of ISA’s briefly explained below;
A Cash ISA is simple savings account with an additional benefit added on a wrapper that states that you will not be paying any taxes on that ISA, meaning there will be no interest rate tax, capital gains tax, or even investment tax. However, there is a limit to how much you can put away yearly in cash ISA. Cash ISA happens to be the most popular as well, as 70% of the total population of the UK has subscribed to a Cash ISA.
Types of Cash ISA
There are a few types of cash ISAs that you can opt for, which are,
Instant Access Cash ISA
As the name suggests, an instant access cash ISA allows you to deposit and withdraw cash from your account whenever you want with no penalties involved. But to keep things fair and offset this advantage, the interest rates offered on this type of ISA are lower than the other kinds of ISAs.
Regular Savings Cash ISA
A regular cash ISA has a fixed interest rate for a period of time. Still, there are a few conditions involved as you would be legally required to deposit a predetermined amount in the account every month. If you opt for a regular savings ISA, you can put aside £1,666 every month and go up to a total of £20,000 in a year.
Fixed-Rate Cash ISA
A fixed-rate ISA comes with many restrictions as you cannot withdraw the amount saved up in the account before a certain period of time. The length of your account’s term is directly proportional to the amount of interest received. If you need the amount for an emergency, you would need to pay penalties to have it withdrawn.
Stocks and Shares ISA
Stocks and Shares ISA is more similar to an investment portfolio, as you can put your money in different funds and stocks, and the incomes, dividends, and growth is protected from taxation. You can have up to £20,000 stashed away in a Stocks and Shares ISA. This investment can be made as a lump sum amount or with payments as low as £20 per month. When setting up for a Stocks and Shares ISA, you are presented with the option of setting up a managed account where your investments are selected for you based on your risk tolerance level, or you can make a personalised investment portfolio and pick where you would like to invest.
However, do note that with Stocks and Shares ISA, there are certain risks involved as a loss incurred by your invested business would also impact your tax-free savings, and you might get a lesser amount than you have invested.
Innovative Finance ISA
Innovative Finance ISAs are the most different as compared to the rest of its variants as it is based on a peer-to-peer lending model. Meaning the money that you have invested in the ISA would be used to lend money to other people, which they would return after a set period of time with an added interest on top. This type of ISA was introduced in 2016 and considered the highest risk ISA, as there was no security against default of the lent amount. However, in 2019 the FCA made an effort towards adding an extra layer of protection by tightening the rules a little, as they stated that financial promotions could only be directly offered to someone who fulfils the following criteria,
- Certified as a “high net worth investor.”
- certified as “sophisticated investors.”
- self-certified as a “sophisticated investor.”
- certified as “restricted investors.”
Help to Buy ISA
Essentially a cash ISA, the Help to Buy ISA was set up to help first-time buyers get ahold of their own properties in the UK. With the Help To Buy ISA, you can put aside £12,000, with up to £200 invested every month and an initial payment of £1,000. The government will add upon 25% taking the total to £15,000; however, this bonus is only applied if the amount is used to purchase a house valued at or less than £450,000 in London, and up to £250,000 outside of London. The accounts are limited to one per person, meaning if multiple users are pooling together to buy a house, they all can benefit from the bonus.
The Help To Buy ISA was available to new savers until 30 November 2019; however, if you already have one set up, you can continue contributing to it until 2029.
The Lifetime ISA was introduced as a replacement for Help To Buy ISA and was brought in to help younger people put aside a certain amount towards a more secure future.
The yearly subscription limit of the Lifetime ISA is currently at £4,000, which is a part of your yearly ISA allowance of £20,000. The remaining allowance can be utilised by putting in money in the other three types of ISA, which is already a considerable upgrade from the Help To Buy ISA.
You can either have Cash Lifetime ISAs or Stocks and shares one. This ISA is suitable for savers who are between the age of 18 to 39. The Government adds a 25pc bonus on every pound invested, up to a maximum of £1,000, each year. Contributions can be made up to the age of 50, however, you will not be able to get a new account created for yourself if you are aged above 40.
Junior ISAs let parents save and invest on behalf of a child under 18. The junior ISA limit is £9,000 per child for the same tax year of 2021/22, and parents can save this amount in addition to their adult allowance. Junior ISAs can be cash or stocks and shares, with interest or investment gains paid tax-free.
But there are a few things you need to consider before engaging in a Junior ISA for your kids. Know that if you have an ISA opened for your kids, they are the rightful owners of the account and you will not be able to withdraw anything from it. As soon as the kids reach the age of 16 they will take over the account and can make the payments, however, to be able to withdraw, they need to at least be the age of 18, at which point the account is converted into a regular adult ISA.
ISA vs Savings Accounts: What You Need To Know!
Are you presented with the option to get an ISA or a Savings Accounts set up but are confused about what would be the best option for you? Let us look at the comparison between a savings account and the most common ISA, the cash ISA, and help you find what you need for your savings.
One of the most major differences between a savings account and an ISA is the tax imposed on the interest you earn during the period you’ve held the account. For a savings account, the government has introduced a personal saving allowance that allows basic rate taxpayers to earn £1,000 through interests. You will have to pay tax on earnings over the limit, however, in the case of an ISA, the entire amount of interest earned is deemed tax-free.
Limitations To Deposit
There is no upper limit to how much you can save up in a savings account until imposed by a bank or building society. You can deposit as much money as you can into a savings account and increase the amount of interest you earn.
Whereas, in the case of an ISA, there is an ISA allowance that limits the deposits you can make towards the account which is currently at £20,000 each year.
With an ISA, you can only open a single Cash ISA account each tax year; however, there is no such limit when it comes to a savings account.
For a savings account, there are a number of providers currently offering a large number of products in the market and you can pick out the one that suits you best. With an ISA, the products offered are limited and there are only a few select providers currently working in the industry.
What Is The Withdrawal Process From An ISA?
You can withdraw the amount invested in an ISA at any time without any tax implications, however, it will affect your annual ISA allowance but there are certain conditions that apply based on the flexibility of your ISA. For example, your ISA allowance is £20,000 and if you had invested £15,000 in your ISA in the year 2021/22 and proceeded to withdraw £5,000, your ISA allowance remaining for that year would be,
- £5,000 in the case of most types of ISAs.
- £10,000 in the case of your flexible Cash ISA. (The allowance will consist of the remaining £5,000 of ISA allowance and the £5,000 you had taken out.)
Will Opening An ISA Affect My Benefits?
Invested money held in an ISA is considered a part of your savings and may affect your claim towards benefits. Especially in the case of a Lifetime ISA as it has strict withdrawal policies, and would also lower the benefits you received based on the fact that you have savings put aside.
In the case of claiming Universal Credit, it is stated that having savings of any sorts valuing more than £6,000 will, assumingly, provide you with some income (regardless if you can access that income or not), and could lower your claim towards Universal Credit. And if the savings grow more than £16,000 in value then you cannot claim for Universal Credit.
With this, you now know all you need to know about ISAs, and if you are wondering if you should start saving up for yourself we advise that you seek the help of professional accountants that can identify your needs and provide you with the most optimal option for an ISA.
Anam has a degree in accounting from the Prestigious St John’s University, and works as a senior director in Clear House.
Before working in Clear House, Anam worked in various commercial roles, the last one being the VP Operations for a prestigious business organisation,working on improving the organisation’s operational efficiency, growth and high level client management.
Anam manages clients ranging from software companies to large property developers and managers. Notably, she recently worked with a large property development company building large scale developments in London and the surrounding area.