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ISAs Explained

ISAs are a tax-free way of saving money in the UK, designed to encourage individuals to save money. In this guide, I’ll explain how much you can invest, the types of ISAs available and what happens if you want to withdraw your money.

1. What is an ISA?

ISA stands for ‘Individual Savings Account’ and it is a type of savings account that encourages UK individuals to save because any interest and capital gains are tax-free. There is a limit on the amount you can save every tax year. For 2020/2021 the maximum amount that you can invest in an ISA is £20,000. The annual investment limit is reviewed annually but it will be the same for 2021/2022 tax year, remaining at £20,000.

Any UK resident over 16 can open an ISA, but you must be:

ISAs are a great way to save money because not only are they tax-free, but, with the exception of the innovative finance ISA, are also risk-free because they have FSCS protection. This means deposits of up to £85,000 are insured in the event a bank goes under, making money up to this limit safe.

2. Types of ISAs

There are four main types of ISAs and you can only open one of each kind during a single tax year.

2.1 Cash ISA

A cash ISA is very much like a traditional savings account but you don’t pay tax on any interest you earn. On traditional bank accounts, you’ll pay income tax on interest earned above the personal savings allowance, which is £1,000 for basic rate tax payers, £500 for higher rate tax payers and £0 for additional rate tax payers.

Cash ISAs are a really easy way to put money aside, but it may not grow you money in the way that other ISAs do.

2.2 Stocks and Shares ISA

Stocks and shares ISAs are also known as Investment ISAs and the money you deposit into your account is invested on your behalf in assets such as shares, bonds and property. That means your money could grow at a faster rate than just receiving bank interest alone.

Stocks and shares ISAs do come with some risk because the value of your investment can go down. But any gains you make are tax-free (gains of this nature would normally be subject to capital gains tax), as well as the interest. So it’s very tax-efficient. You can choose how you invest your money if you prefer, or have your money invested for you by a third party and they’ll invest it normally based on the level of risk you want to go for.

You can withdraw money from a stocks and shares ISA at any time, but they are considered tong-term investments so early withdrawal may mean you miss out on significant gains.

2.3 Lifetime ISA

Lifetime ISAs are available to individuals between the ages of 18 and 40 to help you buy your first home or save for later life.

You can contribute up to £4,000 in to your lifetime ISA every tax year until you reach the age of 50. The government will then match your savings with a 25% contribution, up to a maximum of £1,000 every year.

2.3.1 Withdrawing Money from Your Lifetime ISA

You can withdraw money from your ISA when you:

  • buy your first home **
  • are aged 60 or over
  • discover you are terminally ill, with less than 12 months to live

If you need to make a withdraw for any other reason, you’ll pay a charge which in effect recovers the money the government have contributed to your ISA. This charge is 25% from 6 April 2021 and 20% prior to this date. If you die, there is no charge when funds are withdrawn to be included as part of your estate for inheritance tax purposes.

** You need to meet the following criteria when you buy your first home:

  • the property you buy costs up to £450,000
  • you buy the property at least 12 months after you make your first payment into the Lifetime ISA
  • you use a conveyancer or solicitor to act for you in the purchase – the ISA provider will pay the funds directly to them
  • you’re buying with a mortgage

2.4 Innovative Finance ISA (IFISA)

An innovative finance ISA is a new type of ISA available through online platforms that offer peer-to-peer lending such as the Funding Circle.

Peer-to-peer lending allows people with savings to help those who want to borrow money, typically individuals and start-up businesses.

These types of ISAs do promise higher returns but your funds are not protected by an FSCS guarantee and IFISAs are considered higher risk because there is the chance individuals simply won’t be able to pay the money they’ve borrowed back. That means before you invest your money into this type of ISA, you must weigh up the risks and returns.

3. Junior ISA (JISA)

Junior ISAs are a tax-free savings account for children under the age of 18, who live in the UK. The savings limit for a junior ISA is £9,000 for the 2020/2021 tax year and will continue to be the same for 2021/2022.

There are two types of JISAs available:

  1. Cash Junior ISA,
  2. Stocks and shares Junior ISA

Just like with the adult versions, any interest and gains made are tax-free. Junior ISAs automatically turn into adult ISAs when the child turns 18.

4. When is the 2021 ISA Deadline?

The ISA deadline is 5 April 2021, which is the end of the tax year. You’ll need to have deposited your money into your ISA by this date for it to meet the annual investment limit of £20,000. You’ll have a new limit for the new tax year, which for 2021/2022 remains at £20,000

5. HMRC ISA Helpline

HMRC have set up a dedicated helpline to answer questions when it comes to tax on ISAs, so if you have any questions then this will be a great place to start for free. The number is 0300 200 3300.

About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek, money nerd and creator of www.goselfemployed.co - the UK small business finance blog for the self-employed community. Here she shares simple, straight-forward guides to make self-employment topics like taxes, bookkeeping and banking easy to understand.