What is an ‘ISA’

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The Individual Savings Account – or ISA. Barely a week goes by without it cropping up in the financial columns in some form or another.

Most people will probably have one. But are we aware of where it came from, what it succeeded and the variety of different options they offer?

A very brief history

The ISA was first introduced in the new tax year of 1999/2000. Replacing Personal Equity Plans (PEPs) and Tax Exempt Special Savings Accounts (TESSAs).

A further ‘Junior ISA’ was introduced in 2011 under the then Chancellor of the Exchequer, George Osbourne, to replace the Child Trust Fund. Unlike the the other two above, if you opened one of these before the 2nd Jan 2011, when they were replaced, you can keep it open and continue to contribute to it. Newcomers will have to opt for the JISA.

The facts

Firstly, in order to open an ISA you must have a National Insurance Number (NI), be a resident in the U.K and/ or be a Crown servant, or the spouse of a Crown servant, if you don’t live in the U.K.

An ISA is purely the name given to the ‘wrapper’ around the traditional bank or investment account.

The whole process of opening, managing and withdrawing money from the ISA wrapped account is pretty much the same as any ordinary account used for the same purpose, it’s just the underlying workings that are a little different.

Once opened, an ISA allows the account holder to deposit up to £20,000 into their account from their post-tax income, per tax year (6th April to 5th April the following year).

This £20,000 is accumulative across all different types of ISA account an individual may hold. So, for example, you may deposit £10k in your Cash ISA and 10k in your S&S ISA per tax year (lucky you if you have to worry about this).

You can put more in, but one penny over that £20,000 will become subject to normal tax rules.

You can only contribute to one type of ISA per tax year. You can still open more than one type, but must pick one for the tax year to deposit money into, only. If you accidentally contribute to more than one type, you must contact HMRC immediately to notify them (this will be a simple fix, and is nothing to worry about, as long as you notify them asap).

The 5 types of ISA

There are four types of adult ISA and a further account specifically for those under the age of 18.

Cash

Nice and simple. This is your ordinary savings account just wrapped up in the tax-free £20k a year wrapper.

You will not pay tax on any interest earned on these accounts and you must be 16 or over to open one.*

Stocks and Shares

You must be 18 to open one of these accounts.

Again, this is like a traditional investment account but any capital gains are tax free as long as you don’t contribute more than £20k across all your ISAs within a given tax year.

Many investments qualify under the S&S ISA including shares, funds, bonds, Gilts and investment trusts. But some do not qualify, so you need to make yourself aware of what does and does not qualify, before investing in these.

Lifetime

The newest of the lot. Introduced in April 2017, the Lifetime ISA, or LISA (as in ‘lie-sa’ not ‘Lisa’ from the Simpsons), enables the account holder to deposit up to £4,000 into the account per tax year, where the government will then top up a further 25% bonus after 6-8 weeks of that deposit.

This ISA superseded the Help to Buy (H2B) ISA in 2019. Anyone who opened a H2B before November last year can still contribute to, and use the account up to 2029, but no one else can now open one.

Essentially, with the LISA, you can earn up to £1,000 per tax year for free from the government if you deposit the maximum of £4,000 (25% of £4,000).

You must be at least 18 and under 40 in order to open the account, and the money accrued can only be used towards your first home or after the individual reaches the age of 60.

In order to use the money towards your first house you must be a first time buyer and not have owned property before (including inheritance).

If you’re a couple, both of you can have a LISA, and both can use your separate LISAs together for the same deposit on a house. If one of you has owned property before, the other individual can still use a LISA towards a joint deposit as long as they also haven’t owned property in the past.

Sounds like a no brainer doesn’t it. Well it is of you’re definitely going to use it for a house deposit. However, there is a penalty charge if you want to withdraw your money for any other reason than using it for a house deposit or before you’re 60.

You’ll see a lot of articles and news outlets claiming you’re charged 25% for withdrawing early, which seems extortionate. And it would be if it were true.

Say, for example you deposit £1,000. The government then gives you the 25% bonus. You now have £1,250. You decide to withdraw your money early triggering the early access, ‘25% charge’. You get back 75% of that £1,250 = £937.50. Your actual losses from the contribution YOU made are £62.50 less than the original £1,000 you deposited. This works out at roughly 6.25% charge. This is less scary than it was initially made out by the media, but would still add up if you had a sizeable amount in there so make sure you know that any money deposited is DEFINITELY going towards a house and that you have reserve cash somewhere else that is easily accessible.

You can also have a S&S LISA where you can invest the money you deposit as well as the government bonus, or simply hold it in a Cash LISA. Essentially just the two above ISAs rolled into the Lifetime rules and bonus benefits.

Innovative Finance

A fairly straightforward account. This is an ISA dedicated to Peer to Peer lending. (P2P lending) which you must be over 18 to open.

I’ll do a full post on this in the future, but P2P lending is essentially a form of investment whereby you lend your money to businesses or individuals and receive a rate of return, paid in instalments, eventually receiving the original lump sum you lent at the end of the pre-agreed term.

This is usually done through a platform that acts as the medium between you and the entity you’re lending to; think Ratesetter or Funding Circle (others are available).

Especially in these times, this can be an incredibly risky way of getting a return on your money with little upside, or less than there used to be. Always do your research before jumping in.

Nonetheless, using an Innovative Finance ISA protects any earnings you make through this savings/ investment vehicle from tax, given you don’t deposit more than £20k across all your ISA accounts.

Junior

This ISA must be opened by the parent or guardian of the child who must be under 18; the child cannot open this account themselves.

Any money deposited into the account immediately becomes the child’s, but they cannot access the funds until they turn 18. They can, however, manage the money within the account from 16.

The maximum amount that can be deposited into a Junior ISA this tax yer (2020/21) is £9,000.

Just like the LISA above, the JISA can comes in two forms: Cash and Stocks and Shares.

*

So, some key takeaways:

  • You can contribute up to £20k a year accumulatively across all your ISAs
  • All interest or capital gains made within an ISA account is tax free
  • Both the Lifetime and Junior ISAs can be held in Cash or Stocks and Shares
  • You can only use a Lifetime ISA for your first property OR not until the age of 60
  • The child cannot access their Junior ISA until they’re 18 but can manage it from 16

So there you have it. There might be a few small things I’ve missed, but this is the the very least you need to know about ISAs and the different types you can choose from.

There are many different banks, building societies and brokers who offer ISAs. Always make sure you’re checking if they’re regulated by the Financial Services Compensation Scheme (FSCS) by using their own checker, here.

*Since the introduction of the Personal Savings Allowance, basic rate tax payers are able to earn up to £1,000 in interest a year outside of their ISA savings before paying any tax. Likewise, higher rate tax payers can earn up to £500 a year without paying tax on the interest income.

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