Why are ISAs a useful way to hold your money? Here’s what you need to know

an HMRC form with pound coins scattered around it

Ever since they replaced the now-defunct Tax-Exempt Special Savings Account (TESSA) and Personal Equity Plan (PEP) products in 1999, ISAs have become a favoured option for UK savers and investors to hold their money.

In fact, according to Money Marketing, ISAs were as popular as ever in 2020, with the number of products sold jumping 79% to a five-year high.

But why are ISAs so popular? Find out why these accounts are a useful way for you to hold your money when saving and investing.

ISA tax efficiency can reduce your tax bill

The biggest and most well-known benefit of ISAs is their tax-efficient status.

When you hold money or assets in an ISA, any income generated either from investment returns or in interest is entirely free from Income Tax and Capital Gains Tax (CGT).

This can reduce your overall tax bill compared to saving and investing outside of an ISA.

Bear in mind that ISAs will fall inside the value of your estate. As a result, your beneficiaries may have to pay Inheritance Tax (IHT) on cash or assets within an ISA on your death.

The ISA allowance offers a great target for your money

The next main benefit of using ISAs is that there’s a limit for how much you can save and invest each tax year.

The ISA allowance is the maximum amount each UK adult can contribute across all ISA products in a single tax year. In the 2021/22 tax year, this allowance is £20,000, and will remain so in 2022/23.

While this may not sound like a benefit, it actually sets an ambitious yet potentially reachable target for your saving and investing plans.

A range of saving and investing options

There is a range of ISA products you can use to make the most of the tax efficiency on offer.

Cash ISA

As the name suggests, a Cash ISA allows you to hold your money in cash away from the stock market.

You may think that there’s no risk of tax when holding cash in a savings account. But, if you hold particularly large sums in cash, then the amount of interest you earn could mean you’d need to pay Income Tax on your savings.

There is a Personal Savings Allowance before tax is due on savings. This is £1,000 for basic-rate taxpayers, £500 for higher-rate, and £0 for additional-rate taxpayers. However, any money earned over this limit could be subject to Income Tax.

Meanwhile, by saving in a Cash ISA, you can be confident that you won’t have to pay Income Tax on your savings.

Stocks and Shares ISA

Although cash offers more capital security than Stocks and Shares investments, investing via a Stocks and Shares ISA means you can look to generate returns on your investments without having to worry about any tax charges.

CGT is a particular concern if you have investments held outside of an ISA. CGT is charged on gains in the value of an asset from when you buy it to when you sell it.

So, for example, if you bought shares for £20,000 and sold them for £25,000, you may have to pay CGT on the £5,000 gain.

Each tax year, you do have a CGT annual exempt amount before tax is due, which is £12,300 in 2021/22. However, any gains in value above this amount could be subject to CGT.

This could see you charged a tax bill of 20% on the gains in value above your annual CGT exempt amount if you’re a higher- or additional-rate Income Tax payer. For basic-rate taxpayers, this charge is 10%.

There’s an additional 8% CGT charge on property investments, taking total CGT rates on property to 18% and 28% for basic-rate and higher- or additional-rate taxpayers, respectively.

Meanwhile, by investing through a Stocks and Shares ISA, you’ll be entirely free from having to pay CGT on those investments.

The impact of compounding returns in a Stocks and Shares ISA without having to worry about tax can also be a great reason to consider using one.

Indeed, if you managed to invest the full £20,000 in a Stocks and Shares ISA each tax year for 25 years, then, assuming average annualised growth of 4% a year, you could end up with more than £1 million in your pot.

Lifetime ISA

If you or someone close to you is aged between 18 and 39, they can open a Lifetime ISA (LISA). LISAs are specifically designed for young people to save towards a first home or make an early start on retirement saving.

Each tax year, you can save up to £4,000 into a LISA. This amount does count towards your £20,000 ISA allowance.

For every contribution you make up to this limit, the government will contribute an extra 25%. That means, if you make the maximum £4,000 contribution in a single tax year, you could receive £1,000 in the form of a government bonus.

You can hold cash or stocks and shares in your LISA, or a combination of both.

Bear in mind that there’s a 25% withdrawal charge for LISAs if you take money out for a reason other than buying a first home or retiring before the age of 60. This charge will remove your government bonus plus a small part of your savings.

Save and invest for a child

As well as the £20,000 ISA allowance that each adult has, children also have a separate ISA allowance. In the 2021/22 and continuing into the 2022/23 tax year, this is £9,000.

Using it, you can save and/or invest for your children in Junior ISA (JISA) products.

There are Cash JISAs for saving tax-efficiently without putting your money in the market. Or alternatively, there are also Stocks and Shares JISAs that allow you to invest for your child in the stock market.

You can use your £9,000 allowance across one or both of those products in a single tax year, dividing it between accounts as you choose.

Want to find out more?

If you’d like to find out more about ISAs or you’d like help finding the appropriate account for you, please get in touch with us at Novus.

Email info@novusfs.co.uk or call 01423 870731 to speak to one of our experienced advisers.

Please note

Investments carry risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

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