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What is an ISA and how does it work?
Some choices are simple. Let’s say you have two options for your hard-earned savings and investments. Option 1 is giving money to the taxman and Option 2 is keeping all your money.
If you’re a UK resident, you do have exactly that choice with Individual Savings Accounts (ISAs).
Tax treatments depend on the individual circumstances of each person and might be subject to change in the future.
If you’re a UK resident, you do have exactly that choice with Individual Savings Accounts (ISAs).
Tax treatments depend on the individual circumstances of each person and might be subject to change in the future.
Big ideas
- ISAs are a type of savings account where interest income from savings and capital gains and dividends from investments are shielded from tax.
- They are a government-sponsored scheme to encourage savings and investments subject to a maximum contribution limit (currently £20,000).
- There are different types to consider, including for your children and grandchildren.
What is an ISA?
An ISA is a tax-free saving or investment account for UK residents. You can put your ISA allowance to work and maximise your potential returns by shielding them from income tax, tax on dividends, and capital gains tax.
ISA in UK parlance is sometimes referred to as a Tax Wrapper. Think of them like a force field sitting around your money, keeping the taxman away.
ISA in UK parlance is sometimes referred to as a Tax Wrapper. Think of them like a force field sitting around your money, keeping the taxman away.
What are the UK taxes on investments?
To understand the value of using an ISA, it is worth taking a brief look at how taxes on savings and investments usually work in the UK, without using an ISA. That way you can see what the ISA is protecting you from.
Tax on interest
For cash savings, the tax you pay on interest depends on your income tax band:
- Basic rate taxpayers: The first £1,000 of interest is tax-free, with 20% tax applied to anything above this.
- Higher rate taxpayers: You get £500 tax-free, then pay 40% on any interest over that amount.
- Additional rate taxpayers: No tax-free allowance applies, and 45% tax is charged on all interest earned.
This makes tax-free savings options like ISAs an attractive way to maximise your returns.
Tax on capital gains
This is a tax on the profit made from selling an asset, known as Capital Gains Tax (CGT). You are not taxed on investment profits until you sell the asset and realise the gain.
You have an annual tax-free allowance of £3,000 for profits, after which you pay tax on amounts exceeding this threshold. The rates range from 10% to 28%, depending on your income tax band and the type of asset involved - for example, different rates apply to gains from property compared to stock market investments.
You have an annual tax-free allowance of £3,000 for profits, after which you pay tax on amounts exceeding this threshold. The rates range from 10% to 28%, depending on your income tax band and the type of asset involved - for example, different rates apply to gains from property compared to stock market investments.
Tax on dividends
Many stocks and shares pay out dividends to investors, which is a type of income you receive, and yes, that is taxed too. You get the first £2,000 tax-free and then pay between 7.5% to 38.1% on the rest, depending on what income tax band you are in.
Sadly, there is not a lot that the government doesn't tax! But an ISA is an easy way to avoid all of these (up to a certain maximum contribution), which keeps more in your pocket. Another benefit is that you don’t have to declare them on a tax return or report them in any way.
Sadly, there is not a lot that the government doesn't tax! But an ISA is an easy way to avoid all of these (up to a certain maximum contribution), which keeps more in your pocket. Another benefit is that you don’t have to declare them on a tax return or report them in any way.
What are the different types of ISA accounts?
There are various types of ISAs with different attributes that can help you achieve your investment goals:
DIFFERENT TYPES OF ISA
☑️ Cash ISAs for saving cash
☑️ Stocks and Shares ISAs for investing in the stock market
☑️ Lifetime ISAs for saving to buy your first home (or for later life)
☑️ Junior ISA for tax-free savings and investments for children under 18
☑️ Stocks and Shares ISAs for investing in the stock market
☑️ Lifetime ISAs for saving to buy your first home (or for later life)
☑️ Junior ISA for tax-free savings and investments for children under 18
Choosing the right ISA for your individual investment goals
When deciding which ISA is best for you, consider your preferences and personal objectives. Your strategy should be aligned with your financial goals. Each ISA type can serve you with a different purpose and advantages. Understanding the various ISA features and limitations is key to optimise their use. Let’s sum them up:
Cash ISA
Typically offered by banks and building societies, Cash ISAs are known for their interest rates and often for their flexibility. Interest rates can be fixed or floating and can go up or down depending on the access you have to your funds. Some Cash ISAs would limit your access to the funds for a fixed term, while others allow you to withdraw at any time.
Before engaging in a Cash ISA, it is good to explore the options available and consider which one is best for you and your investment goals. Whether you pick a Cash ISA with a fixed term and higher interest or instant access at a lower rate, this ISA type offers a good opportunity for passive income.
The Trading 212 Cash ISA stands out with its competitive AER (variable), zero account fees, and the flexibility to withdraw your funds anytime - all while earning tax-free interest daily.
The best part is that you can combine your allowance usage with another ISA type or choose to use all of it within your Cash ISA. For instance, you can add money to a Lifetime ISA or Stocks and Shares ISA while contributing to a Cash ISA or putting all money into the Cash ISA.
To open a Cash ISA, you need to be at least 18 years old. For Stocks and Shares ISAs or Innovative Finance ISAs, the age requirement is also 18, while Lifetime ISAs require you to be between 18 and 39.
Before engaging in a Cash ISA, it is good to explore the options available and consider which one is best for you and your investment goals. Whether you pick a Cash ISA with a fixed term and higher interest or instant access at a lower rate, this ISA type offers a good opportunity for passive income.
The Trading 212 Cash ISA stands out with its competitive AER (variable), zero account fees, and the flexibility to withdraw your funds anytime - all while earning tax-free interest daily.
The best part is that you can combine your allowance usage with another ISA type or choose to use all of it within your Cash ISA. For instance, you can add money to a Lifetime ISA or Stocks and Shares ISA while contributing to a Cash ISA or putting all money into the Cash ISA.
To open a Cash ISA, you need to be at least 18 years old. For Stocks and Shares ISAs or Innovative Finance ISAs, the age requirement is also 18, while Lifetime ISAs require you to be between 18 and 39.
This is the ISA type that allows you to invest in stocks and various assets while making the most of your savings. An important aspect to note is that investments within this ISA can fluctuate in value as markets are volatile. Therefore, it's crucial to consider the risks associated with investing in different securities and market exchanges. Yet, higher risk levels can also mean higher potential returns. An advantage is that you won't be taxed on any earned interest, income, or dividends.
Unlike Cash, Lifetime, and Help To Buy ISAs, which primarily hold cash, a Stocks and Shares ISA allows for a diverse range of investments such as shares, funds, investment trusts, exchange-traded funds (ETFs), and corporate and government bonds. For instance, the Trading 212 Stocks & Shares ISA provides access to a wide selection of individual company stocks and ETFs.
You have the option to maximise the allowance limit set by HMRC or divide it among various ISA types. It's permissible to contribute funds simultaneously into both a Stocks & Shares ISA and a Cash ISA or any other type of ISA.
You have to be at least 18 years of age to open an S&S ISA. The allowance for the 2024/2025 financial year set by HMRC is up to £20,000.
In a Stocks and Shares ISA, generally, you can include the following types of investments:
Unlike Cash, Lifetime, and Help To Buy ISAs, which primarily hold cash, a Stocks and Shares ISA allows for a diverse range of investments such as shares, funds, investment trusts, exchange-traded funds (ETFs), and corporate and government bonds. For instance, the Trading 212 Stocks & Shares ISA provides access to a wide selection of individual company stocks and ETFs.
You have the option to maximise the allowance limit set by HMRC or divide it among various ISA types. It's permissible to contribute funds simultaneously into both a Stocks & Shares ISA and a Cash ISA or any other type of ISA.
You have to be at least 18 years of age to open an S&S ISA. The allowance for the 2024/2025 financial year set by HMRC is up to £20,000.
In a Stocks and Shares ISA, generally, you can include the following types of investments:
- Funds
- Shares
- Investment trusts
- Exchange-traded funds (ETFs)
- Government bonds (gilts)
- Corporate bonds
Any investments held inside an ISA account will not be subject to income tax, tax on dividends or capital gains. So why don’t we just put everything inside an ISA? The answer is that there is a maximum allowance for how much you can deposit per year.
Lifetime ISA (LISA)
Lifetime ISA’s purpose is to help people buy their first home or build a savings pot for later in life. This type of ISA has the lowest subscription limit of all. Investors can add up to £4,000 each year until they are 50 but can take out the savings when they are buying their first home or if they are 60 or over.
The benefit of this ISA type is that the government adds a 25% bonus on the savings per year. For instance, if the maximum limit is used, a bonus of £1,000 will be added by the government. The first payment towards this ISA type must be made after the investor turns 18 and before 40.
The Lifetime ISA can hold both cash and stocks, depending on the provider. Once the investor turns 50, the 25% bonus will be discontinued, and they won’t be able to make new payments. More on Lifetime ISAs can be found on the government website.
The benefit of this ISA type is that the government adds a 25% bonus on the savings per year. For instance, if the maximum limit is used, a bonus of £1,000 will be added by the government. The first payment towards this ISA type must be made after the investor turns 18 and before 40.
The Lifetime ISA can hold both cash and stocks, depending on the provider. Once the investor turns 50, the 25% bonus will be discontinued, and they won’t be able to make new payments. More on Lifetime ISAs can be found on the government website.
Junior ISA
The Junior Individual Savings Account (Junior ISA) is a long-term, tax-free savings option for children under 18, designed to help parents or guardians build a financial foundation for their child's future. For instance, in the 2024/25 year, the limit was set for £9,000.
Junior ISAs have replaced the previous Child Trust Funds (CTFs). If your child has a CTF, you can transfer it into a Junior ISA to potentially benefit from better terms or rates.
There are two types of Junior ISAs:
Junior ISAs have replaced the previous Child Trust Funds (CTFs). If your child has a CTF, you can transfer it into a Junior ISA to potentially benefit from better terms or rates.
There are two types of Junior ISAs:
- Cash Junior ISA: Earn tax-free interest on savings.
- Stocks and Shares Junior ISA: Invest in stocks and shares with tax-free growth.
The child can have one or both types, with the combined contributions not exceeding the annual limit.
Word of warning with Junior ISAs. Be aware that the children get control over the account when they turn 16 and can start withdrawing when they are 18.
Word of warning with Junior ISAs. Be aware that the children get control over the account when they turn 16 and can start withdrawing when they are 18.
- Control of the account: At 16, the child can assume control of the account, but withdrawals are only permitted at 18.
- Opening an account: Parents or legal guardians can open a Junior ISA for children under 16. Children aged 16 or 17 can open their own Junior ISA.
Flexible ISA
Last but not least, we have to talk about Flexible ISAs and what they really are. How do they work, and how your subscriptions are affected when you transfer or withdraw funds from them?
This ISA type enables you to replace money that you have previously withdrawn without counting it towards your allowance limit. When a withdrawal is made, new deposits within the same tax year will count toward the limit only when the withdrawn amount has been fully replaced.
This ISA type enables you to replace money that you have previously withdrawn without counting it towards your allowance limit. When a withdrawal is made, new deposits within the same tax year will count toward the limit only when the withdrawn amount has been fully replaced.
You can choose to save across multiple accounts, as long as you don’t exceed the annual allowance for the current tax year, set at £20,000 at the time of writing.
A Lifetime ISA has a reduced allowance of just £4,000 per year and a Junior ISA differs too with an allowance of £9,000 per year. These allowances fit inside the UK tax year which runs from 6th April to 5th April.
A Lifetime ISA has a reduced allowance of just £4,000 per year and a Junior ISA differs too with an allowance of £9,000 per year. These allowances fit inside the UK tax year which runs from 6th April to 5th April.
Benefits of opening an ISA
ISA type | Subscriptions limit* | Investments type | Age restrictions |
Cash | 20K | Cash | At least 18 |
Stock and Shares | 20K | Stocks, ETFs, bonds | At least 18 |
Lifetime | 4K | Cash, stocks, ETFs, bonds | Between 18 and 40 |
Junior | 9K | Cash, stocks, ETFs, bonds | For children under 18 |
* The limits are as per HMRC’s guidelines for 2024/25. As of the 2024/25 tax year, the minimum age to open a Cash ISA has been increased to 18 years. Previously, individuals aged 16 or over could open a Cash ISA, but this has now changed.
ISA withdrawals
You can use your annual allowance in full with either a cash or an investment ISA or an innovative finance ISA, paying up to £20,000 in the current tax year.
Alternatively, you can split your ISA allowance, using it as you wish across the four different types (subject to individual account limits), as long as you don’t pay in more than £20,000 across them all, and no more than £4,000 into the Lifetime account.
You are limited to using only one of each type in each tax year. A Junior ISA is counted outside of your allowance since that is technically in the name of the dependent you opened it for.
Alternatively, you can split your ISA allowance, using it as you wish across the four different types (subject to individual account limits), as long as you don’t pay in more than £20,000 across them all, and no more than £4,000 into the Lifetime account.
You are limited to using only one of each type in each tax year. A Junior ISA is counted outside of your allowance since that is technically in the name of the dependent you opened it for.
EXAMPLE
Imagine, you deposited £10,000 and you decided to withdraw £1,000 later on. The balance in your ISA might be £9,000, but your current tax year subscriptions will remain £10,000. So if you decide to add more money afterwards in the same tax year, it will be added on top of your original £10,000, not the new £9,000 value.
This year (2023), if you want to use a Lifetime ISA, you can deposit £4,000. You can then spread the remaining £16,000 of your allowance across any of the others in whatever proportion you want. If you don't want to use one, you can simply put in £20,000 in any one of the other 3, or a combination if you like, as long as you don’t exceed the total £20,000 allowance.
ISA Rules and Maximum Contributions
ISAs are a powerful tool for building wealth in the UK, offering tax-free returns on savings and investments. Each tax year (6 April to 5 April), you can save or invest up to £20,000 across a combination of ISA types. This includes Cash ISAs, Stocks and Shares ISAs, Innovative Finance ISAs, and Lifetime ISAs. For those under 18, the Junior ISA has a separate annual allowance of £9,000.
The flexibility of ISAs allows you to allocate your allowance across multiple accounts or concentrate it into one, depending on your financial goals. For example, you might choose to contribute £10,000 to a Cash ISA and the remaining £10,000 to a Stocks and Shares ISA.
Remember, you can only open and contribute to one of each type of ISA per tax year. By understanding the rules, you can make the most of your allowance and shield your savings from income tax, capital gains tax, and tax on dividends.
The flexibility of ISAs allows you to allocate your allowance across multiple accounts or concentrate it into one, depending on your financial goals. For example, you might choose to contribute £10,000 to a Cash ISA and the remaining £10,000 to a Stocks and Shares ISA.
Remember, you can only open and contribute to one of each type of ISA per tax year. By understanding the rules, you can make the most of your allowance and shield your savings from income tax, capital gains tax, and tax on dividends.
Transferring to a new ISA provider
You can transfer your ISA from one provider to another at any time and you can transfer your money to a different type of ISA or to the same type of ISA. If you want to transfer the money you've invested in an ISA during the current year, you must transfer all of it.
With the Trading 212 Stocks and Shares ISA, you can move as much of your ISA contributions from previous tax years as you like. However, if you wish to transfer the money you already put into your ISA this tax year, you'll need to transfer all of this year’s pot together.
Generally speaking, transfers take around 30 days, but this does vary depending on what providers are involved.
To instruct a transfer, you go to your new desired provider and follow their process to request it for you. If you’re transferring to Trading 212, you’ll need to complete an ISA Transfer Authority Form. Trading 212 will then handle the process directly with your current provider to start the process.
With the Trading 212 Stocks and Shares ISA, you can move as much of your ISA contributions from previous tax years as you like. However, if you wish to transfer the money you already put into your ISA this tax year, you'll need to transfer all of this year’s pot together.
Generally speaking, transfers take around 30 days, but this does vary depending on what providers are involved.
To instruct a transfer, you go to your new desired provider and follow their process to request it for you. If you’re transferring to Trading 212, you’ll need to complete an ISA Transfer Authority Form. Trading 212 will then handle the process directly with your current provider to start the process.
Recap
ISAs are almost indispensable wealth-building tools for those residing in the UK that are worthy of some serious consideration for savings and investments.
For instance, with the Trading 212 Stocks and Shares ISA, you can invest for the long term while retaining the ability to withdraw funds when needed. Keep in mind, however, that the value of investments can fluctuate, and your account balance may differ from what you initially invested. To access your funds, investments must be sold, with the proceeds transferred back to your account as cash.
Before committing to any ISA, it’s essential to understand the withdrawal rules specific to your chosen account type. This knowledge ensures you can make informed decisions and maximise the benefits of your ISA while keeping your savings aligned with your goals.
For instance, with the Trading 212 Stocks and Shares ISA, you can invest for the long term while retaining the ability to withdraw funds when needed. Keep in mind, however, that the value of investments can fluctuate, and your account balance may differ from what you initially invested. To access your funds, investments must be sold, with the proceeds transferred back to your account as cash.
Before committing to any ISA, it’s essential to understand the withdrawal rules specific to your chosen account type. This knowledge ensures you can make informed decisions and maximise the benefits of your ISA while keeping your savings aligned with your goals.
FAQ
Q: Is an ISA better than a savings account?
ISAs offer tax-free growth, but there caps on how much can be deposited in a year. They typically also have higher interest rates than savings accounts. Savings accounts offer more flexibility in terms of withdrawals and deposits, but you will be taxed on the interest earned.
Q: What is the benefit of an ISA?
ISAs are a great way to save for your future, whether you're looking to buy a new home, save for retirement, or simply have a rainy day fund. The tax-free growth on your savings means that you can grow your money faster than in a standard savings account, and the flexibility to withdraw money whenever you need means that you're never tied down.
Q: Is it worth having an ISA?
If you have a good income and are able to save regularly, an ISA could be a good option for you. They offer tax-free savings and can be used for a variety of purposes, including retirement planning. If you have high-interest debt, such as credit card debt, it may be a better idea to focus on paying that off before saving into an ISA. Ultimately, whether or not to have one is a personal decision.
Q: What are the pros and cons of an ISA?
The main pro of an ISA is the tax-free growth of your savings. This means that any interest you earn on your savings will not be subject to income tax, which can save you a significant amount of money over time. The main con of an ISA is that you are limited in how much you can contribute to your account each year.
- Fixed Interest Rates: Interest rates that remain constant for a specified period, providing predictable returns on savings or investments.
- Floating Interest Rates: Interest rates that fluctuate over time based on market conditions, central bank policies, or other economic factors.
- Passive Income: Earnings generated with little to no active involvement, such as dividends, interest, or rental income.
- Funds: Pooled investments where multiple investors contribute money, which is then managed by professionals to invest in various assets.
- Shares: Units of ownership in a company, giving shareholders the right to a portion of profits and, in some cases, voting rights.
- Investment Trusts: Publicly traded companies that invest in a portfolio of assets on behalf of shareholders, similar to mutual funds but structured as companies.
- Exchange-Traded Funds (ETFs): Investment funds that track an index, sector, or asset class and are traded on stock exchanges like individual shares.
- Government Bonds: Debt securities issued by a government, typically considered low-risk investments that pay fixed interest over time.
- Corporate Bonds: Debt securities issued by companies to raise capital, offering periodic interest payments to investors.
- Tax Year: The 12-month period used by governments to assess and collect taxes.
