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Full ISA Guide Save without paying tax

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Many people think ISAs are complicated. But they're simply tax-free or tax-efficient accounts into which you can place either cash or investments.

Here, we answer your most common questions about ISAs for adults to help you get to grips with everything you need to know, including the changes taking place in July. There's also a section on junior ISAs for kids.

Q. What is an ISA?

A. If you've got any savings, or investments, you should have an ISA - it's as simple as that. The reason? You pay less tax (or no tax in the case of cash savings) and therefore increase your returns. It's a no-brainer! For years, we've used the same analogy to explain ISAs. So why stop now? Here come the cakes!

A real life ISA example

Q. Who can open an ISA?

A. You need to be a UK resident aged 16 or over to open a cash ISA, or aged 18 or over to open a stocks & shares ISA. You can't open an account together with someone else, or on behalf of someone else. There's also a mini version for kids, called a junior ISA, which works in a similar way.

Q. What ISA should you pick?

A. There are two types of ISA - one you can use for cash savings and one you can use for investing.

Cash ISAs explained

Use a standard instant access savings account, and basic rate taxpayers have to give 20% of the interest earned straight to the Government. For higher rate taxpayers, this leaps to 40%, and for 'additional rate' taxpayers, it's 45%.

NO tax to pay!

Cash ISAs are simply savings accounts where the interest isn't taxed, meaning it's incredibly rare for a normal savings account to pay more interest.

For a cash ISA paying 2% AER to be beaten, a basic-rate taxpayer would need a savings account offering 2.50%, while anyone paying higher-rate tax would need 3.33% - and those accounts currently aren't out there for the vast majority of people.

Just like normal savings accounts, there are a variety of cash ISAs available, such as instant access, fixed rate, and accounts with base-rate guarantees. You don't have to pay to open a cash ISA. For details of the best payers, read Top Cash ISAs - updated daily.

Stocks & shares ISAs explained

You can also use an ISA for investing. This type of ISA is called a stocks & shares ISA, where you can invest in funds (shares or bonds from various companies pooled into one investment), bonds (basically a loan to a company or a government), and shares in individual companies.

Stocks & shares ISAs are typically managed by an online service (often called an online broker or platform), fund management group or fund supermarket.

If you wish to open a stocks & shares ISA, you need to be aware that many of these companies charge a fee for you to open and hold a stocks & shares ISA. Some even charge you if you want to change any of your investments, withdraw your money or move it to another company.

For the cheapest way to buy stocks & shares ISAs, read the Stocks & Shares ISA guide.

Tax benefits:

Placing investments inside an ISA wrapper doesn't mean they're tax-free, but doing it provides three tax advantages:

  • No tax on profits. You don't have to pay any capital gains tax on profits made from share price increases - outside an ISA, any profits made above the annual capital gains tax allowance (£11,000 for 2014/15) would be subject to tax at 18% for basic-rate taxpayers and 28% for higher-rate and additional-rate taxpayers. You make a profit when you sell a share for more than you bought it for.
  • No tax on interest earned on bonds. So you get to keep it all.
  • 10% tax cap on income. This means income earned from any shares investments is taxed at 10%. So while basic-rate taxpayers would pay the same outside an ISA, this is a significant saving for higher and additional-rate taxpayers who would otherwise pay higher rates of 32.5% and 37.5% respectively.

Remember, there's ALWAYS a risk involved when investing, as your investments can go down as well as up. The general consensus is that it's a long-term game - you should put money away for a minimum of five years to smooth out any ups and downs.

Q. How much can you put into an ISA?

A. Each tax year, you get an ISA allowance which sets the maximum that can be saved within the tax-free wrapper from April to April.

The current limit is £11,880, up to half (£5,940) of which can be in the form of cash. The whole chunk could be used for investing if you wish.

How you can split your allowance before July 2014:

  • Use the maximum cash allowance only. For the current 2014/15 tax year, you can put £5,940 into a cash ISA, leaving £5,940 available to fill with investments (though you obviously don't have to use this). From 1 July it increases to £15,000 (see below).

  • Use it all for investing. You're allowed to invest up to £11,880 this tax year, although this leaves no room for tax-free cash savings. From 1 July it rises to £15,000 (see below).

  • Mix 'n' match. Any amount under £5,940 can be saved in cash, then the rest of your £11,880 allowance put in a stocks & shares ISA. So someone saving £2,000 in a cash ISA has £9,880 left to invest.

How you can split your allowance after July 2014:

  • Use the maximum allowance for cash or investing. From 1 July, the allowance will rise to £15,000 and for the first time, all of it can be put in a cash New ISA (NISA), the new name for ISAs. Alternatively, you could invest the whole lot in a stocks & shares NISA.

  • Mix 'n' match. Split the allowance between and cash and stocks & shares NISAs - you're allowed one of each per tax year.

You must save or invest by 5 April, the end of the tax year, for it to count for that year. Crucially, any unused allowance doesn't roll over - so if you don't use it, you lose it forever.

Any savings or investments which stay within the tax-free ISA wrapper will continue to earn interest and reap the tax benefits until you withdraw the money.

This means it's possible to have substantial amounts invested within ISA wrappers: £7,000 per year from 1999 to 2008, £7,200 per year until 2010, £10,200 for 2010/11, £10,680 in 2011/12, £11,280 for 2012/13, £11,520 for 2013/14, £11,880 for 2014/15, then rising by inflation each year after that, plus the gains (interest or investment returns) made in each year.

Q. Should you get a cash or investment ISA?

A. This isn’t about choosing which one is best - that depends purely on your attitude to risk. It's about whether you gain more from putting savings into an ISA or using your ISA allowance for investing.

The gain from putting cash into an ISA is simple: you don’t get taxed on the interest.  But with investing, whether you actually gain from putting it in an ISA depends on your circumstances.

  • Are you eligible for capital gains?  Stocks & shares ISAs exempt you from capital gains tax (a tax on profits which you only pay when you sell your investments).  Yet you can make £10,900 a year of profits before being hit by this tax, so this protection only helps those who are selling sizeable assets within one tax year – otherwise it's irrelevant.
  • Will you put money into bonds?  If you’re investing in bonds such as corporate bonds or Government gilts, then you get the income without it being taxed in any case. For other bonds, a stocks & shares ISA will shelter the income from tax.
  • Will you get an income? If you receive dividend income, it's taxed at 10% for basic, 32.5% for higher, and a whopping 37.5% for additional-rate taxpayers. Within a stocks & shares ISA the max dividend income tax is 10%, regardless of your tax status. So while it's no different for basic-rate payers, it can represent a significant saving for others.

IN SHORT: Small investors who won’t use their capital gains and are putting cash in shares investments will gain more using their cash ISAs to the limit, then putting the rest in shares.  Big investors, especially those putting money in bonds, should max out their stocks & shares ISAs.

Q. How can you withdraw money?

A. A common mistake is to think an ISA needs to be held for a set length of time in order to reap the tax-free benefits. Luckily, that's wrong. Providing the rules of the individual product allow it (there are loads that do), you can have full, instant access to your money without losing the tax benefits on the rest of your savings within the ISA.

But once the money's withdrawn, it can't be returned. A few examples should help clarify this.

Situation: Mr Rich Devil invests £11,880 in a stocks & shares ISA at the beginning of the tax year.

Options: He may sell the whole investment, or part of it, at any time without losing the tax benefits. But he can't put any more money into his ISA that year.

Situation: Ms Irma Indecisive invests £2,000 in a cash ISA at the start of the tax year.

Options: She may save up to a further £3,940 in the cash ISA, or £9,880 in a stocks & shares ISA (or a mix of the two) before the end of the tax year.

Situation: Irma then decides she needs to withdraw £1,000 of this cash.

Options: There's no problem withdrawing the money; while the £1,000 was in the ISA its interest wasn't taxed. However, the fact she has withdrawn the cash doesn't increase her allowance at all - she can still only put £3,940 more in the cash ISA, or £9,880 in the stocks & shares ISA.

It's also worth noting that if you have an ISA that pays interest annually, and you decide to close your ISA before the interest is due to be paid, you will still get the accrued interest paid on the account (less any penalties for closure/withdrawal - check your T&Cs).

Q. Can you get an ISA for your kids?

A. Yes, you can. There's a version for kids called a junior ISA (JISA). Just like the adult version, it allows you to save tax free or tax efficiently on behalf of a child. You can save or invest for your child, or do a bit of both.

    Junior ISAs in a nutshell:

  • You can save up to £3,840 a year into a JISA - only a third of the adult ISA. This rises to £4,00 on 1 July.
  • You can divide the annual allowance whichever way you like - so you can put it all in cash or all in stocks & shares.
  • Your child can't touch the money until they turn 18 - The account is held in the child’s name but is opened and managed by you. The child can take control at 16, but can't touch the cash until 18.
  • Your child can only hold a cash JISA with one provider - and it works the same with a stocks & shares JISA. This means you top up with the same provider each year. If you're unhappy with the provider or you spot a better deal somewhere else, you can always transfer your child's JISA to another company.

JISAs replaced Child Trust Funds when they were scrapped for new savers on 3 January 2011. This means JISAs are only available to children born on or after that date, or children aged under 18 but born before 1 September 2002, when the CTF was introduced, and so never had the chance to contribute to a CTF. 

When your child turns 18, the money belongs to them to do with as they like. You might want them to use the money for a house deposit or studying, but they could decide to blow it all on partying - and you wouldn't be able to stop them.

INTERESTING FACT: If your child is 16 or 17, they get two ISA allowances - the junior ISA allowance PLUS the adult cash ISA allowance of £5,940.

 

Q. Can you switch provider once you're set up?

A. There's nothing stopping you switching provider for cash or stocks & shares ISAs. In fact, to make sure you continually get a top rate, this will be essential, particularly for cash ISAs. Yet it isn't like switching a standard savings account, as transferring an ISA is a technical process.

As long as you abide by our golden ISA transfers rule, it should go smoothly:

Never, ever, ever, ever withdraw the money yourself!
You'll immediately lose all the tax benefits.

Instead, speak to the new provider and fill out a transfer form. Your new provider should then sort it all out, including contacting your current provider, and moving the money over for you. If you transfer a stocks & shares ISA, it may be necessary to pay another initial charge. Some stocks & shares ISA providers also charge you for withdrawing your money or leaving them.

That's the key thing to remember. But when transferring ISAs, what you can do depends on which type of ISA you want to transfer.

    Transfer rules:

  • Current year's cash ISA. You can move ALL of this to another cash ISA, or into a stocks & shares ISA. You can't split it into more than one provider or ISA type.

  • Current year's stocks & shares ISA. You can move ALL of this to another stocks & shares ISA, but you can't move it to a cash ISA, or split it between more than one stocks & shares ISA.

  • Past years' cash ISAs. You can move ALL of this to another cash ISA or into a stocks & shares ISA, or you can SPLIT it between more than one cash ISA or stocks & shares ISA.

  • Past years' stocks & shares ISAs. You can move ALL of this to another stocks & shares ISA, or SPLIT it between more than one stocks & shares ISA. You can't move any of it into cash ISAs.

Not all ISA providers will accept transfers of previous years' allowances. To see the best ones that will, read the Transferring Cash ISAs guide.

Following a ruling by The Office of Fair Trading, a transfer should take no more than 15 days.

Q. What about Tessas, PEPs and mini ISAs?

A. Personal equity plans (PEPs) and tax-exempt special savings accounts (Tessas) were forerunners to ISAs during the 1980s and '90s. Once ISAs were introduced, there were also mini and maxi ISAs.

All these tax-free savings accounts have now been converted into ISAs.

If you had cash in a mini ISA, this is now just a cash ISA. A mini shares ISA is now just a stocks & shares ISA. And if you had a maxi ISA (a combination of cash and shares) then the shares element will be a stocks & shares ISA, and the cash element a cash ISA.

Tessa and PEP cash will also now be cash ISAs. It's worth checking any old accounts, as it's likely they're all paying rubbish rates of interest. See the Transferring Cash ISAs guide for the current top payers. All these accounts accept any old cash ISA savings.

If you think you had either of these investments, or a standard ISA, but are now not sure what's happened to it, it's possible to track down old accounts and reclaim the funds (plus any interest) inside them. Read the full Reclaim Forgotten Cash guide.


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