The tax year in the UK doesn’t run from January to December like a normal year. Instead, for arcane reasons, it starts on the 6th April.
The ISA year is the same, since the purpose of holding an ISA is to shield your savings and investments from the greedy taxman.
Every year you are given an ISA allowance, which you must either use, or discard – you can’t carry it forward into future tax years.
You will want to make the most of your ISA allowance before it’s too late.
We’re going to tell you what you need to be doing with your savings and investments before the end of the ISA year, your options for the new ISA year, what we’ve done to get prepared, and answer some common questions our viewers regularly have about using their ISAs correctly.
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Why An ISA?
An ISA (individual savings account) is a type of savings account where you don’t pay any tax on interest, dividends or capital gains. Over the years, this tax benefit can save you tens or even hundreds of thousands of pounds.
The maximum amount you can deposit into an ISA each year is £20,000, and as your ISA balance grows it remains free from tax year after year.
You could in theory, and some people have done exactly this, build your ISA to in excess of £1m and there would still never be any tax on it.
Who’s Taking Advantage Of Their ISA Allowance?
The most recently released HMRC ISA statistics shows a downward trend in people taking advantage of ISA accounts since the financial crash of 2008, when interest rates were slashed:
The fall is mostly in Cash ISAs, probably for this reason of falling interest rates. But 11.2m people were still choosing to protect their wealth from HMRC as of April 2019 – roughly 17% of the population.
But of the 17% of the UK using an ISA, only around 20% of them use their full allowance, so are receiving the full benefit – this tiny band therefore reflects just over 3% of the UK population.
We did a full study on ISA statistics in this video here, including splits by gender, income, and average savings per year, so check that out next if you love statistics as much as we do!
Do You Even Need An ISA?
The general publics’ view on ISAs seems to be that they are pretty much pointless.
If they are only offering 0.5% interest rates, you may as well just have a savings account, or even a high interest current account, right?
This is sort of true for Cash ISAs – not so for other types. Let’s look at Cash ISAs first.
For most people, any interest they will likely receive these days in a savings account will be so small as to be untaxable anyway – whether that’s in an ISA, or not.
Most people in the UK get a personal savings allowance (PSA), separate to any ISA accounts, which means all interest you make on savings are likely to be tax-free.
Basic 20% rate taxpayers can earn up to £1,000 interest a year without needing to pay tax on it, meaning you’d need £200,000 of cash earning 0.5% interest before you’d begin to be taxed.
Higher 40% rate taxpayers get an allowance too, but it is lower at £500.
So, Cash ISAs do look pretty pointless. What about Stocks & Shares ISAs?
Again, there is limited benefit to be gained from an ISA if you only have a small amount invested in the stock market, since everybody gets dividend and capital gains allowances too.
The dividend allowance of £2,000 means you’d need £50,000 in stocks earning a 4% yield before dividends became taxable.
You would likely be safe too from capital gains tax at this level, since you can sell stocks for profits of £12,300 in any one year before tax is due.
In many cases a general account may be better if your provider charges you to use an ISA.
But if your goal is to grow your wealth over the years, we think an ISA is almost essential. Part of the strategy of long-term wealth building via ISAs is getting your money into it each year while you can, up to the full ISA allowance.
You can’t just drop £50,000 into an ISA – you have to add it in gradually over a number of years.
And if you can’t think of anything to invest in right now, that’s fine – you can deposit into a Stocks & Shares ISA and hold that money in there as cash for as long as you want.
When you’re ready, which might even be in a future tax year, you can use the cash that you previously deposited into your ISA to buy investments with.
Just make sure you use up your allowance, and you can worry about investing later!
Do You Need To Inform The Tax-Man?
Also, using an ISA avoids the need to declare your dividends and capital gains on a self-assessment tax form at the end of the tax year.
Any profits made in an ISA have a privileged status in that the tax man legally doesn’t need to know anything about them.
You only need to tell HMRC about dividends and capital gains on shares made outside of ISAs if they are above the relevant allowance thresholds.
How Does The Allowance Work?
As we said earlier, none of your £20,000 allowance rolls over, so for example if you only put £15,000 into an ISA, you can’t carry the remaining allowance of £5,000 into the following year.
Basically, it’s use it, or lose it.
Amounts that are deposited and then withdrawn in the same tax year still usually count towards your allowance.
Say you deposit £15,000, then a couple of months later withdraw £10,000, leaving you with £5,000. The most you could then top your ISA up by in this same tax year would be a further £5,000.
In total HMRC says you have saved £20,000 and used your full allowance, even though in reality you’ve only saved £10,000.
Some providers do offer flexible ISAs allowing withdrawing and redepositing, but these are less common.
Finally, any dividends, capital gains and interest you make in the ISA don’t count towards your allowance, so don’t worry about profits holding you back – they won’t.
What Are My ISA Options?
#1 – Cash ISAs
So, there’s Cash ISAs – for the reasons already mentioned, we personally don’t see much point in these.
A further (and we think the main) point against them is that the returns are lower than inflation, making them terrible as a means of growing wealth.
The top Cash ISAs currently available offer between 0.4% and 0.62% – find these on MoneySavingExpert.com – and remember while you do so that inflation is typically 2-3%!
Premium bonds currently average a better return than cash ISAs and are also tax-free, so for whatever cash you have to hold, premium bonds might be a better place to store it.
#2 – Stocks & Shares ISAs
Your next, and in our view, best option is a Stocks & Shares ISA. You can invest in the stock market while being protected from capital gains tax, dividend tax, and tax on interest from bonds and cash.
That’s all the major taxes covered, but you’ll still receive some foreign dividends after the deduction of foreign dividend withholding tax.
The stock market has returned around 8% annually on average over the last 120 years or so – quite a bit more than inflation. The downside is that this has to be seen as a long-term commitment, since some years will see your money go down, alongside the good years.
The main thing to watch out for in a Stocks & Shares ISA is fees – the main ones on your radar should be the platform charge, any management fees on funds, and trading and FX fees when you buy and sell investments within your ISA.
We’ll soon mention some investment platforms that offer low fee ISAs, which have minimised or removed trading fees entirely.
#3 – Lifetime ISAs (LISAs)
First-time homebuyers saving into a Lifetime ISA can save up to £4,000 into this account each year tax-free, and the government will top it up by 25% – up to an extra £1,000.
They come in both Cash and Stock Market varieties.
They are also seen as an alternative to a pension, since they are designed for the dual purposes of house purchases and retirement planning. Withdrawals for any other purpose will be penalised.
We think on balance a pension is still the best place to hold your old age retirement pot for most people.
#4 – Innovative Finance ISAs
The Peer-to-Peer Lending market is slowly opening up again after the pandemic, and we still have several welcome offers for free cash rewards on the Offers page from Peer-to-Peer providers, most of which offer Innovative Finance ISAs.
This ISA type protects your Peer-to-Peer Lending investments from tax.
An important point on ISA types is that you can deposit into multiple ISAs each tax year, but only into one from each type.
And your total deposits must not exceed £20,000 a year across all of them combined.
Time To Switch ISA Provider
The start of the ISA year is a great time to switch ISA provider. If you’re in the market for a new, better ISA, there’s one thing you should never do.
NEVER withdraw money from your ISA account to put it into your new one. If you do, you’ll immediately lose its tax-free status and waste your new year’s allowance by redepositing money that was already sheltered.
Instead, you need to follow the simple transfer process. Make sure that the new provider you want to use accepts transfers – not all do – and then fill in the ISA transfer form with the new provider.
ISA transfers should take no longer than 15 working days for transfers between cash ISAs and 30 calendar days for other types of transfer.
Top Stocks & Shares ISA Providers
Stocks & Shares ISAs come in different flavours, the main difference being between “Do-It-For-Me” providers and “Do-It-Yourself” providers.
If you want an easy life or don’t know enough to feel confident about investing, Nutmeg are our favourite “Do-It-For-Me” platform.
Check out our Nutmeg overview at the Best Investment Platforms page, and if you sign up via the MoneyUnshackled website, they’ll knock your management fees down to 0% for the first 6 months as a special offer.
If you want to manage what goes into your ISA by yourself, on this page you’ll also find overviews of our favourite “Do-It-Yourself” ISA providers – some of which also have welcome offers. There’s also a comprehensive cost comparison table.
Don’t Forget The Kids
Junior ISAs, known as JISAs for short, are tax-free havens for kids that work in a similar way as the adult versions of Cash ISAs and Stocks & Shares ISAs.
But the amount you can save into one tax-free each year is less at £9,000, and you or they can’t withdraw from the account until the child is 18. And the money is legally theirs – no take backs!
We can’t give you advice, but we would only consider a Junior Stocks & Shares ISA for a child. Nothing else makes sense.
Over the long-time frame of 18 years, the stock market will almost certainly reap huge returns for your kid, while cash is almost guaranteed to lose value to inflation.
We’re Ready For The New ISA Year
We’ve already deposited our full ISA allowances, so we’re now waiting eagerly for the new ISA year to kick start on the 6th April.
In doing so, we happily join the 3% of Brits who are taking advantage of this sweet incentive to grow wealth. Will you be among them too?
What are you doing to prepare for the ISA deadline? Join the conversation in the comments below!
Featured image credit: Serge Vo/Shutterstock.com