Introduction to the TAX-FREE World of ISAs
ISAs are great opportunity to save your money with no (or low) risk. ISAs are Individual Savings Accounts with instant access to your money (certain types of Cash ISA) designed to help you reach your savings goal. Thanks to the government’s support, ISAs are a great way to legally avoid paying any tax on your financial gains, simply put, all profits you gain on any ISA account is exempt from any tax.
What is an ISA?
An ISA (Individual Savings Account) is a specific savings account exempt from both income tax and capital gains tax on the investment returns. Also, tax is not payable when money is withdrawn from the plan. You just never pay any tax on it; it's as simple as that.
Who can open an ISA?
Restrictions to open a new ISA are as simple and logical as can be. You must be a UK resident in the following age categories for each ISA:
- 16+ years old for a Cash ISA
- 18+ years old for a Stocks and Shares ISA or IFISA
- 18+ years old or over but under 40 for a Lifetime ISA
- Junior ISA is available for younger children.
To be precise and to cover all possibilities, we have to add that according to gov.uk, ISA accounts are also available to Crown servants (e.g. diplomatic or overseas civil service) or their spouse or civil partner not living in the UK.
Different types of ISA
The first ISAs (Cash ISA and Stocks and Shares ISA) were launched in 1999 when they replaced the earlier PEPs (Personal Equity Plans), which were very similar to a Stocks and Shares ISA and TESSAs (Tax-Exempt Special Savings Accounts), which were very similar to a Cash ISA. Since their launch, ISAs have undergone a number of changes and also other types of ISA accounts have derived from these base versions.
The 4 basic types of ISAs:
- Cash ISA
- Stocks and Shares ISA
- Innovative Finance ISA (IFISA)
- Lifetime ISA
Other derived types of ISAs:
- Junior ISA
- Help to buy ISA
- Inheritance ISA
- Flexible ISA
What is the ISA subscription limit?
An ISA subscription limit tells you how much you can put into each of your ISA accounts for the current tax year. The tax year runs from 6 April to 5 April. For tax year 2018/19 is ISA subscription set up to £20,000.
The historical growth of the ISA subscription limit
- Years 1999/2000 to 2007/2008: £7,000
- 2008/2009: £7,200
- 2009/2010: £7,200 *
- 2010/2011: £10,200
- 2011/2012: £10,680
- 2012/2013: £11,280
- 2013/2014: £11,520
- 2014/2015: £11,880 **
- Years 2015/2016 and 2016/2017: £15,240
- Years 2017/2018 and 2018/2019: £20,000
* In the tax year 2009/2010, the ISA subscription limit was £10,200 for adults over 50.
** From 1st July 2014, the ISA subscription increased to £15,000.
Because you can open each type of ISA account with a different provider, it’s also important to keep in mind, not to oversubscribe more than your ISA subscription limit allows for that year. The ISA subscription limits apply to everyone on an individual basis. If you are married or in a relationship, both of you can hold your own ISA accounts, with the full subscription limit.
How much can I put into each type of ISA?
Every tax year you can open an ISA account where each account has a different allowance for a fiscal year. In tax year 2018/19 the allowance is:
- £20,000 into Cash ISA
- £20,000 into Stocks and Shares ISA
- £20,000 into Innovative Finance ISA
- £4,000 into Lifetime ISA
Thanks to the relaxed rules for money allocation, you can save your full amount annually either to one single ISA account or divide it across all or just some of the types of ISA accounts.
Example #1 – Full ISA subscription into one type of ISA
You could save your full ISA subscription limit of £20,000 into either Cash ISA or Stocks and Shares ISA that allow you to save exactly £20,000 in one tax year.
Example #2 – Subscription divided across more than one type of ISA
You could save £5,000 into Cash ISA (to have an instant access to money), £4,000 in a Lifetime ISA (to reach the highest government contribution), £9,000 in a Stocks and Shares ISA (for long-term investment) and the remaining £2,000 in an Innovative Finance ISA; all within one tax year.
To use all of your annual ISA allowance, remember to deposit the money into your tax-free account before midnight 5th April 2018.
If you want to open an ISA shortly before the end of the tax year (e.g. between 1st and 5th of April), please note that it takes some time for financial institutions to process your application and the account might not be ready to deposit any money. So, it’s best not to leave things to the last moment, especially for accounts set up.
What happens if I've paid too much into my ISA?
Although this situation is not very common, it has happened from time to time. Thanks to ISAs’ flexibility for transferring money between your opened ISAs accounts, it became very easy to manage your money effectively but it’s also prone to making errors exceeding your annual limit, as well, especially when withdrawing or transferring from more than one account to another.
Suppose that you deposited too much money to your ISA accounts during one tax year and it was a completely unintentional mistake; it is not considered a deliberate tax fraud. In this instance, you should follow general recommendations; don't try to fix your mistake by yourself but rather let HMRC know as soon as possible.
Although there is no automated mechanism to control if the limit is exceeded individually, throughout the year ISA providers report how much each of their customers has invested using NI and other identifiers. So HMRC does have this information available. Once the exceeded limit has been identified by HMRC they will automatically refund the difference. And you will have to pay tax relating to any gains on this money.
“We will identify the error and contact the investor to sort things out. There are ordering rules about which subscriptions are 'invalid' and if the investor does the wrong thing and removes some subscriptions now, we may contact them and say that, in fact, monies held with the other manager must be removed. The position is only cleared after the end of the tax year when we can look at what has happened,” said a spokesman for HMRC.
HM Revenue & Customs (HMRC) has an ISA helpline on 0300 200 3312. Give HMRC a call and flag that you have exceeded the limit. [https://www.gov.uk/government/organisations/hm-revenue-customs/contact]
Withdrawing money from an ISA
Generally speaking, you have instant access to your ISA money. You can withdraw money at any point of time, without losing your tax-free benefit. But different ISA accounts could lead to different restrictions and conditions. This originates directly from the ISA providers. (e.g. if you withdraw your money at the time your limit is reached, some institutions may not allow you to put money back in to reach the limit again).
Obviously, there is a difference between a Cash ISA where you keep your money in the form of cash with instant access and a Stocks and Shares ISA where your money is further invested. If you want to get your money back from Stocks and Shares ISA, the first obvious step is to sell all your existing positions in the market (stocks, funds etc.) and then request to transfer your money to a bank account. This process will take a few days before you can actually access your ISA funds. But this transaction can be considered as an almost instant access transaction.
Always check the terms and conditions of each type of ISA account you are opening to avoid any surprises, especially if you planning to open a Lifetime ISA. A Lifetime ISA has different rules for withdrawing your money and it’s specified how the money you’ve saved can be used to attain a governmental contribution.
Flexible ISA and “non-flexible” ISA
With regards to withdrawing money from an ISA, there is one more interesting point worth mentioning: withdrawing money affects your annual allowance limit. The advantage of a Flexible ISA is that the taking money out and putting it back again during the same tax year does not affect your allowance limit.
This is how it looks in practice during one fiscal year. Suppose your ISA allowance is £20,000 and you make a deposit of £10,000 into an ISA account. The remaining allowance is £10,000. If you then take £5,000 out; the remaining allowance amount you can now put into this ISA account until the end of the tax year is:£15,000 if your ISA is flexible (the remaining allowance of £10,000 plus the £5,000 you took out) or £10,000 if your ISA is not flexible (just the remaining allowance)
For opening a Flexible ISA, you need to check with your bank or building society, whether they offer Flexible ISAs and can open one for you.
What happens to my old ISA in a new fiscal year?
For savers, a new fiscal year means three major things.
Firstly, old ISAs (meaning ISAs opened in previous fiscal years) are closed for any further allowance and it doesn't matter whether you have used up all of your ISA limit or just part of it.
Secondly, you can open a new ISA with a new ISA subscription limit. But ISA subscription limits could change, so be sure you keep searching for information updates to avoid any an unexpected mistakes.
Thirdly, good news at the end... You can keep your existing ISAs opened for as long as you keep the money in your ISA account. It also means, all savings, investments, and their returns will continue and remain on a tax-free basis and reap the tax benefits for you.
Where can you open an ISA account?
Generally speaking, you can open a Cash ISA online with any provider that you choose. It’s a quick process and normally what you need are your personal details, NI information, and proof of address. You can do this online, by visiting your bank branch, or over the phone.
The list of ISA account providers in the UK is enormous. Individual providers can be grouped as:
- Building Societies
- Credit Unions
- Friendly Societies
- Stock Brokers
- Peer-to-Peer Lending Services
- Crowdfunding Companies
- Other Financial Institutions
Once you do your research and you’ve selected your optimal provider, get in touch with them directly and search for information such as: what % p.a. do they offer (this is for Cash ISAs), what are the charges, how quickly can you access the money, and in the case of investing in a fund, where can you get daily updates of your ISA account.