Anyone, who is a taxpayer and has money to save or invest, should look at Individual Savings Accounts (ISAs).
These are “wrappers” in which someone can hold a range of savings and investment products. They are free of UK income and capital gains tax by anyone aged 18 or over (16 or over for cash ISAs).
ISAs serve as a ‘wrapper’ to protect savings from tax. They allow individuals to invest, within certain limits, each tax year. The main benefits are:
- No personal tax (income or capital gains) on any investments held within an ISA
- Income and gains from ISAs do not need to be included in tax returns
- Money can be withdrawn from an ISA at any time without losing the tax breaks
There are four types of ISA:
- Stocks & shares; which can hold investment funds and other products.
- Cash; which usually contain a savings account.
- Innovative Finance (IF-ISA); which contain 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.
An individual can invest their allowance in stocks & shares, cash, innovative finance or lifetime ISAs. They could split it between more than one type, up to the annual limit of £20,000. They could do this with the same provider or different ones. However, the most someone can pay into a Lifetime ISA is £4,000.
Anyone can transfer money they have saved in previous years’ cash ISA holdings to stocks & shares ISAs and vice versa. This does not affect their allowance. Innovative Finance ISAs cannot be transferred to other ISA wrappers.
Who can hold an ISA?
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. The only exception to this is individuals aged 16 or 17 who can invest up to £20,000 in a cash ISA. Anyone investing in an ISA must be either a resident in the UK. Crown servants serving overseas and their spouses, if they go with them, can invest also.
When someone stops being eligible to invest in an ISA, any existing ISAs will continue to be exempt from UK tax. However, no more contributions can take place.
How much can someone pay in?
The current ISA overall annual contribution limit is £20,000. For Lifetime ISAs, it is £4,000.
What are the tax consequences of holding an ISA?
Any investment returns received from an ISA will be tax-free. There is no personal tax on any income taken and no capital gains tax on any gains made.
What if happens to someones ISA when they die?
On the death of an ISA holder, their ISAs would form part of their estate for Inheritance Tax purposes. This would only not be the case where the ISA invests in shares which qualify for Business Relief.
If an ISA saver in a marriage or civil partnership dies, their surviving spouse or civil partner will inherit their ISA tax advantages. They will be able to invest an extra amount equal to the value of the deceased’s ISAs, on top of their usual allowance. The subscriptions can be made to either a cash or stocks & shares ISA, in cash or the inherited non-cash ISA assets.
How can someone take money out of an ISA?
ISA holders can take their money out at any time. All withdrawals are free of tax. Where the ISA has adopted “Flexible ISA” rules, someone can pay back in whatever they have taken out. The only limit is that the payments in should take place in the same tax year as the withdrawals.
Lifetime ISAs have rules on when someone can take money out them.
What are the risks?
There are many risks anyone considering an ISA need to think about:
- Governments can and do change the rules on tax-efficient vehicles, like ISAs.
- There is no guarantee an ISA will be worth more in the future and it could be worth less.
- Income generated from investments held in ISAs is variable and is not guaranteed.
- Taking income may erode the capital value of the ISA and may be unsustainable.
- Past performance is no guarantee of future returns.
- If growth is low, charges may eat into the capital invested.
- When funds invest in overseas assets, the value will go up and down in line with movements in exchange rates as well as the changes in the value of the fund’s holdings.
- Where a fund invests in emerging markets, its value is likely to move up and down to a higher degree and more often than one that invests in developed markets. These markets may not be as strictly regulated, and securities may be harder to buy and sell than those in more developed markets. These markets may also be politically unstable, which can result in the fund carrying more risk.
- Where a fund invests in fixed interest securities, such as company, government, index-linked or convertible bonds, changes in interest rates or inflation can contribute to the value of the investment going up or down. For example, if interest rates rise, the value is likely to fall.
- Where a fund invests in derivatives as part of its investment strategy, over and above their use for managing the fund more efficiently, under certain circumstances, derivatives can result in large movements in the value of the fund. The fund may also expose itself to the risk of the issuer of the derivative not honouring their obligations, leading to losses.
- Cash/Money Market Funds are different from cash deposit accounts, and their value can fall. Also, in a low-interest-rate environment, the product or fund charges may be higher than the return.
- Where a fund invests in property funds, property shares or direct property, properties are not always readily sellable, which can lead to times when fundholders are unable to ‘cash in’ or switch part or all their holding. Property valuations are made by independent valuers but are ultimately subjective and a matter of judgement Property transaction costs are high due to legal fees, valuations and stamp duty, which will affect the fund’s returns.
- High Yield Bond funds invest in non-investment grade bonds which carry a higher risk that the issuer may not be able to pay interest or return capital. Also, economic conditions and interest rate movements will have a more significant effect on their price. There may be times when these bonds are not easy to buy and sell.
The Financial Services Compensation Scheme
The FSCS exists to protect clients of FCA authorised firms. It covers deposits, insurance, and investments. It compensates individuals who lose money due to their dealings with FCA authorised firms where the firm cannot pay the claims themselves. This is usually because they are insolvent or have stopped trading. The limit of protection varies between assorted products.
A key factor when recommending providers is financial stability. We regularly review this. Any assets they hold for a client are held separately. These assets are ring-fenced from any creditors of the provider.
The same is true for any investment funds we recommend. If the fund manager were to go into default this should not affect the underlying assets of the fund. The FSCS would only come into play if the manager was negligent and could not pay the claims arising from this. The FSCS would cover the outstanding compensation up to £85,000 per person for each fund manager. They do not pay cannot claim compensation just because the value of an investment falls.