What is an ISA?
ISA, standing for individual savings account is essentially a tax wrapper, so think of it like a jacket for your account. If your money is sat in an account, with whatever the underlying investments may be, an ISA can surround this money like a tax efficient jacket. With this jacket, anything within the account grows tax free – meaning any investment gains and growth are completely free of tax, any gains in stocks and shares are free of capital gains tax and any withdrawals are tax free.
Simply put, an ISA is a tax free savings account.
What are the different types of ISAs?
As ISAs have developed over the years, there are many different types of ISAs to consider. The most common one being the cash ISA.
A cash ISA is a deposit based savings account. You put your money into an account and it gains interest over the course of the year. All it simply does is take a deposit account, puts it inside of an ISA and then all the proceeds within that deposit account are completely tax free. With a cash ISA you can invest up to £20k – this investment will then grow and the growth you gain from it will be completely tax free.
Cash ISAs are great for young people wanting to start saving early on in life as they can be accessible from the age of 16.
With cash ISAs you can usually take your money out whenever you need to, however some cash ISAs will have restrictions and they may be termed accounts. This means you might have to leave the money in the account for a year or a few years to qualify for whatever offer is being presented from an interest incentive.
Although cash ISAs are the most common type of ISA and give you access to emergency funds whenever you need them, there are still risks involved. The main risk to consider is the inflation risk – as we see the cost of goods and services increase year on year, our savings keep in line with that inflation rate. Therefore, the money you deposit into a cash ISA loses its buying power, so it will not buy you the same amount of goods and services in the future if interest rates are not growing at the same rate as inflation.
Investment ISAs are a good option if you are looking for an alternative to a cash ISA. With investment ISAs you can have underlying investments of stocks, shares and bonds of ones you already have or ones you are thinking of making. With these types of investments, there’s going to be tax involved if they aren’t put into an ISA, so it’s about sheltering these investments and putting them inside an investment ISA. As is the case with a cash ISA, there’s a £20k limit that you also need to consider.
Additionally, there is a minimum age of 18 for anyone wanting to have an investment ISA. This is because there’s a greater aspect of risk involved with these types of cases. Stocks and shares, for example, can go down in value and it’s those fluctuations that will create an element of risk to your capital, meaning they suit a more mature age group for investment purposes.
Any returns from your investment, whether it be income, dividends or capital gains tax are all free from tax.
Cash ISAs vs Investment ISAs
When looking at the two side by side, despite their obvious differences, they are two types of ISA that need to be treated differently.
With investment ISAs, you need to leave your money in the account for a long period to essentially give it time to grow, it’s best to view them with a medium to long term investment period.
Whereas with a cash ISA, unless it’s termed, you can access the money as and when you need it.
Innovative finance ISAs
Another type of ISA to consider is an innovative finance ISA. These are where you make a loan to another business. There are a lot of businesses and people out there who want to borrow money and we can facilitate that by lending money to these companies. Interest is then gained on this loan and the interest you gain is completely tax free.
As with cash and investment ISAs, you can put up to £20k into an innovative finance ISA.
There are risk elements involved with innovative finance ISAs. The businesses or people you are lending the money to could default on the repayments, so it’s important you have a higher attitude to risk if you want to put your money into an innovative finance ISA.
Lifetime ISAs were first developed for first time home buyers or people looking at saving for retirement. This is because you can contribute into a lifetime ISA anywhere between the age of 18, up to the age of 40 and you can’t take any money out of this fund until you’re 50.
The great thing about lifetime ISAs is the bonus that gets added from the state. There will be a 25% bonus that gets added on top of the contributions that you put in. However, there is a £4k contribution limit with lifetime ISAs and each of these contribution limits are applicable to each tax year.
Lifetime ISAs are a great long term way of saving a healthy amount of cash. If you are contributing into something from the age of 18, up until the age of 50 – the possible bonus you can get from state contributions is around £33k and this is essentially ‘free money’.
As the name would suggest, junior ISAs are for people under the age of 18. We have just seen a sizable increase to the limit you can put into a junior ISA and it has gone from £4k to £9k.
The important thing to consider with a junior ISA is that the funds cannot be accessed until you’ve reached the age of 18.
When you put money into an ISA, can you take it back out again?
In most instances you can take money out of an ISA once you’ve contributed. Essentially it is your money and if you wish to access it, you have a right to do so. But you have to remember a few key points.
Some ISAs, such as lifetime ISAs will carry penalties for withdrawing from your ISA within certain time frames due to the government incentive. If it’s a fixed term ISA, there can also be a notice period for your withdrawals – if you wish to withdraw your money any earlier, you may come into contact with a penalty for doing so.
With investment ISAs, your underlying investments will need to be sold in order to withdraw your funds. As is the nature with investments, the value of them may have fallen so when it comes to selling them, you could have lost out on some growth if you withdraw at the wrong time.
Can you put money back into an ISA once you have withdrawn it?
Prior to 2016, this wasn’t possible. However, a new flexible cash ISA has been made available with certain providers.
A flexible cash ISA permits you to replace your money that you’ve withdrawn and not lose the allowance you previously utilised, so long as you do so within the same tax year.
If you’re looking to put money back into an ISA you need to do so with great caution and we advise you to consult a financial advisor before doing so.
Who can get an ISA?
To access an ISA you need to be a UK resident and if you’re an individual investor, your age will determine the ISA you are going to be eligible for. Even if you’re as young as 16, there are ISA options that can be explored to help you start saving money from a young age.
Should you go to a bank or an advisor?
It’s quite uncommon to approach a bank if you’re looking to put money into an ISA because now more than ever, people want to know their options and they expect a certain level of advice – both of which can be provided by a specialist advisor. If you’re speaking to an individual bank, it’s likely they’re going to offer you the products they offer, rather than giving you the option to look at many other offers from varying providers.
As an experienced advisor, we also offer specialist funds that will suit clients that have certain ethical requirements to consider. We can also offer ISAs that suit varying attitudes to risk – some people have a lower risk appetite and others will be striving for higher returns at a greater level of risk, so it’s important you have ISA options to suit your individual needs and this is something an advisor like us will be able to offer.
We will also consider whether ISAs are the right thing for you to enter into – on paper they are a great way to save money, but it’s important we approach your situation carefully and figure out if ISAs are the best avenue to explore.