A Beginner's Guide To ISAs
ISAs are tax-free savings or investment accounts. This means that the interest or capital gains you earn from any savings or investments made into these accounts are not taxed.
The amount of money you can save into an ISA changes each year; in 2019-2020 the allowance is £20,000. Your allowance must be used up in each tax year by April 5th and cannot be rolled over from year to year.
There are six types of ISAs – Cash, Stocks and Shares, Help to Buy, Junior, Innovative Finance and Lifetime.
A cash ISA is essentially the same as a traditional savings account except you do not pay tax on the interest you earn and there are limits on the amount of cash you can save each year. As with traditional savings accounts you will have options of regular savings or lump sum deposits, easy access or fixed term accounts, and variable rates or fixed rates.
Whatever type of account you choose, it’s important to read the fine print before opening your account, as you may need to meet certain requirements to qualify for the advertised interest rate.
A cash ISA is ideal if you have short-term savings goals and a low tolerance for risk. Keep in mind though that with low interest rates and returns, the effect of inflation could erode the value of your savings pot.
Stocks and Shares ISA
A Stocks and Shares ISA allows you to choose from a range of investments where the capital gains and income are protected from taxation. Unlike a cash ISA, you can choose from many investment vehicles including funds, trusts, bonds, and individual shares.
The rate of return of a Stocks and Shares ISA is dependent on the performance of your investments and if the value of your investments go down, so does the value of your savings pot.
A Stocks and Shares ISA is ideal for people who are looking for a long-term investment and who are comfortable with a higher level of risk set against the possibilities of higher rates of returns. However, you should be aware that if the value of your investment goes down you may get back less than you paid in.
Help to Buy ISA
A Help to Buy ISA is designed to help first-time buyers save for a deposit on a home. You can open a Help to Buy ISA with a lump sum of up to £1,200 and can deposit up to £200 per month up to a maximum of £12,000. These accounts are available at a number of banks, credit unions, and building societies.
To be eligible to use a Help to Buy ISA for your deposit the home you wish to purchase must:
- be in the UK
- have a purchase price of up to £250,000 (or up to £450,000 in London)
- be the only home you will own
- be where you intend on living
- be purchased with a mortgage.
The Help to Buy ISA counts towards your Cash ISA allowance and could preclude you from having another standard Cash ISA However, some banks allow you to split your annual ISA allowance of £20,000 between both ISA accounts.
The big advantage of a Help to Buy ISA compared to the standard Cash ISA is that the government tops up your savings by 25% as long as certain conditions are met.
For example, if you save the maximum amount of £200 per month, the government will top up your savings with an additional £50 each month, up to a maximum of £3,000 over the term of the ISA, for you to put towards your deposit for your home purchase. To qualify for the Help to Buy ISA, you must:
- be aged 16 or over
- have a valid National Insurance number
- be a UK resident
- be a first-time buyer, and not own a property anywhere in the world
- not have another active cash ISA in the same tax year (with some exceptions.
The government has announced that Help to Buy ISAs will no longer be available to new savers after 30th November 2019. If you want to save into a Help to Buy ISA you need to open an account before the end of November.
Junior ISAs are for UK residents under the age of 18 and allow up to £4,368 in deposits each year. There are two types; Cash Junior ISAs and Stocks and Shares Junior ISAs with the allowance shared across both.
The only difference between a Junior ISA and a standard ISA for an adult is the savings limit. Anyone can pay into a Junior ISA on a child’s behalf and when the child turns 18, the account is converted to a standard ISA.
Innovative Finance ISA (Ifisa)
The UK government introduced the Innovative Finance ISA in 2016. It is designed for people to lend money through FCA-regulated and approved peer-to-peer (P2P) lending platforms and receive tax-free interest and capital gains.
You can only have one Innovative Finance ISA and the amount you invest forms part of your overall ISA allowance.
Like the Stocks and Shares ISA, peer-to-peer lending can be more volatile (risky) than a standard cash ISA. Your returns are not guaranteed, and your rates of return will be largely dependent on the performance of your peer-to-peer loan portfolio.
This investment vehicle is ideal for someone who understands peer-to-peer lending and is comfortable with the potential for high rates of returns or losses.
Lifetime ISA (LISA)
The Lifetime ISA, or LISA, is designed to help people with two life events: a home purchase or retirement. Individuals must be between the ages of 18 and 40 to open this account. You can contribute up to £4,000 in a LISA each year, which forms part of your £20,000 annual ISA contribution limit. The LISA can hold cash or stocks and shares or a combination of both.
Even if you decide to purchase a home with your LISA, you have the option of keeping the account so you can continue to save for retirement. Like the Help to Buy ISA, the LISA the government will add a bonus of 25% on your contributions.
For example, if you open a LISA when you are aged 18 and contribute £4,000 per year the government will add another £1,000 (25% of £4,000) each year until you turn 50 making a total of £33,000. This is the maximum bonus you can receive assuming you open your account at 18 and pay in maximum contributions each year until you turn 50.
A LISA is ideal for people who want to save for a home purchase or retirement. You should be aware that if you make any early withdrawals or close your account you will have to pay a 25% charge. This means that you could get back less than you paid in if you treat your LISA as a short-term savings product.
Other savings options
Until April 2016 most people had to pay tax on interest on all personal savings. After that date the government introduced a Personal Savings Allowance (PSA) to allow basic rate tax payers to earn up to £1,000 in tax-free interest.
Despite the introduction of the PSA there are still benefits to ISAs that can help shelter the earnings from your savings from tax. You should also be aware that as savings interest rates rise, so will the amount of tax you’ll owe on your interest earnings.
As your savings balance grows, you could start to earn enough interest that takes you over the PSA due to a combination of a higher balance and possibly higher interest rates. At this stage, the need to protect your interest earnings in an ISA will be more relevant. Finding the right ISA for you will be essential for both your long-term and short-term saving plans.
If you’re still not sure which ISA is right for you, then you should seek advice from a professional.
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