WHAT IS AN ISA?
An Individual Savings Account (ISA) is a type of savings or investment account where you can save or invest entirely tax-free.
Each year, the Government sets an ISA allowance which represents the maximum amount you can save or invest via ISA accounts. In the current tax year (2020/21 tax year), the ISA limit is set at £20,000.
WHAT ARE THE DIFFERENT TYPES OF ISA?
There are currently five different types of ISA, four of which are subject to the individual £20,000 ISA allowance and available to adults only (16+). The Junior ISA is subject to its own separate limit and available to those under 18 only – see below for further detail.
A Cash ISA is just like a standard cash savings account except no tax is payable on income generated via the accounts.
Cash ISAs will typically fall into one of three buckets: 1) easy-access, 2) fixed rate savings and 3) variable rate savings.
The interest rates paid in easy access ISAs are generally lower but come with the added flexibility of enabling cash withdrawal at any point.
Fixed interest accounts give you a guaranteed interest rate, which is typically higher, but requires you to lock in your cash for a set period of time. Whilst some fixed accounts will allow you to withdraw early in exchange for a penalty fee, others simply won’t allow withdrawal during the fixed term.
Variable interest accounts will pay a rate of interest which typically varies as the Bank of England base rate changes. Commonly, fixed interest ISAs will convert into variable rate ISAs once the initial term has passed.
STOCKS AND SHARES ISA
A stocks and shares ISA can be used to acquire individual company shares, funds, bonds, investment trusts or ETFs.
Most of the major online share dealing platforms allow you to invest via a stocks and shares ISA (e.g. Hargreaves Lansdown, Fidelity, AJ Bell YouInvest or Interactive Investor). Both dividends and capital appreciation on investments held in a stocks and shares ISA are tax-free and do not have any impact on your dividend or capital gains allowances.
As with such investments made outside of an ISA, the recommended holding time for such investments is 3+ years as whilst equity markets can fluctuate, they have historically risen over time.
INNOVATIVE FINANCE ISA (IFISA)
Innovative Finance ISAs were launched in the 2016/17 tax year to encourage private investors to invest in peer-to-peer lending platforms such as Loanpad or Kuflink. Peer-to-peer lending (also known as P2P) was pioneered in the UK with the launch of Zopa in 2005.
Peer-to-peer lending involves matching private investors with borrowers who wish to take out loans. Different peer-to-peer firms concentrate on different types of borrowers (e.g. private individuals seeking funds for home improvements, businesses seeking working capital loans or property developers looking for development finance). When you invest in peer-to-peer lending, you acquire a proportion of a loan to one of these borrowers. For example, a property development loan of £0.5 million may be financed by 10,000 investors who each have a £50 share of the loan.
Some platforms enable you to self-select your loans and perform your own due diligence (e.g. AblRate), others automatically spread your funds across a large portfolio of loans to borrowers deemed creditworthy by the platform (e.g. Loanpad) and some platforms offer both options (e.g. Assetz Capital, Kuflink).
Many peer-to-peer investment platforms have mechanisms to allow you to exit your investment prior to the end of the underlying loan term, though such features are subject to sufficient investor demand driving liquidity.
Peer-to-peer lending is riskier than leaving your money in a bank savings account as whilst loans may be secured against underlying assets, there is no FSCS protection. However, to compensate for this increased risk, peer-to-peer loans features the potential for higher returns. For example, Loanpad currently offers a ‘classic’ account in which you can invest up to £20,000 at 4.0%. The account features daily access, subject to sufficient investor demand. Whilst this is not guaranteed, Loanpad has so far been able to maintain this offering throughout the recent Coronavirus crisis.
The FCA has imposed a limit of 10.0% of investable assets for new private investors in P2P. This limit is intended to protect private investors who may not necessarily fully understand the risks involved. We believe that peer-to-peer lending has a strong future as an asset class, but agree that the 10.0% guideline is a sensible level of exposure.
Introduced in the 2017/18 tax year, Lifetime ISAs are primarily designed for people looking to buy their first home, but can also be used as for retirement savings. The maximum amount that can be saved via a Lifetime ISA is £4,000 each year – this forms part of the larger £20,000 individual ISA allowance.
The Lifetime ISA can take the form of a cash savings account or an investment LISA which is akin to a stocks and shares ISA. All cash saved or invested in a Lifetime ISA is boosted by 25.0% by the Government. This gain crystallises at the point of buying your first home or upon reaching age 60. These accounts are only available to those aged 18-39.
If you are considering using a lifetime ISA to save for retirement, you should take some time to consider the advantages and disadvantages of investing in a LISA vs. SIPP vs. workplace pension scheme.
The Junior ISA (also known as the JISA) is a tax-free wrapper in which parents can save money tax-free in a Cash Junior ISA or Stocks and Shares Junior ISA. In the current tax year (2020/21 tax year), the JISA limit is set at £9,000.
Your child must be under 18 and living in the UK to qualify (unless you are a Crown Servant with dependent children living outside of the UK). Once the account is setup, anyone can contribute money to the pot, subject to the maximum overall annual limit.
The cash can be accessed by your child once they turn 18 years old. If preferred, the account will automatically convert to an adult ISA.
CAN I INVEST IN MULTIPLE ISAS?
Yes, subject to the maximum £20,000 allowance across the various types. Within this limit, a maximum of £4,000 may be saved within a Lifetime ISA.
In each tax year, you are allowed to open one of each ISA type. For example, one Cash ISA, one Stocks and Shares ISA, one Innovative Finance ISA and one Lifetime ISA. You could not, however, open two different Cash ISA accounts in the same tax year.
You are allowed to open separate ISA accounts of the same type across different tax years, however. For example, if you opened one Cash ISA in the 2018/19 tax year, you could open another cash ISA in the 2019/20 tax year.
In addition, whilst you could not open two different Innovative Finance ISA accounts in the same tax year, you could open one IFISA and one Cash ISA in the same tax year, and then transfer the Cash ISA to a separate IFISA in the following tax year.
CAN YOU TOP UP ISAS OPENED IN PRIOR TAX YEARS?
You can only contribute to one of each type of ISA each tax year. For example, if you had a Hargreaves Lansdown Stocks and Shares ISA account in the prior year, and you wanted to top it up this year, you would not be able to open any other Stocks and Shares ISA accounts in the current year.
This would not stop you transferring a different ISA opened in a prior year into a separate Stocks and Shares ISA (E.g. If you had a separate Cash ISA you wanted to transfer to a Fidelity Stocks and Shares ISA), but no further funds could be added.
HOW DO ISA TRANSFERS WORK?
ISAs can be transferred from one provider at another at any time.
Current year ISAs must be transferred to another provider in full, as partial transfers are not permitted. However, ISAs opened in prior years can be transferred either in full or in part.
In order for an ISA transfer to take place, the assets within the ISA must be liquid (i.e. cash, or readily convertible to cash). For example, you would not be able to transfer funds held within an Innovative Finance ISA to another provider if there was insufficient liquidity in the platform for you to be able to exit your investment.
ISA transfers may be subject to a fee, so always check with your current provider before making the request.
WHEN IS THE ISA DEADLINE?
The ISA year mirrors the tax year. This means that every year, you have until 5 April to use up your ISA allowance
IF SAVING FOR RETIREMENT, SHOULD I INVEST IN A LISA, WORKPLACE PENSION OR SIPP?
This choice will largely depend on your own personal financial circumstances and specifically, the tax banding you fall into (basic, higher rate or additional rate taxpayer).
Read our guide on the advantages and disadvantages of investing in a LISA, workplace pension and SIPP for retirement savings to learn more.