David Harrowven looks at current ISAs and their advantages, limits, and regulations
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Individual savings accounts (ISAs) were introduced on 6 April 1999. During 2013-14 alone, some 13.5 million adult ISAs were subscribed to (although this was a drop of more than 1 million from the previous year), with nearly 80% of the subscriptions being for cash ISAs – approximately £57 billion was invested. ISAs continue to evolve and, after being reformed into a simpler product last year, further changes are on the horizon including the introduction of a Help to Buy ISA. Junior ISAs have extended availability to children, with around 430,000 junior ISAs subscribed to in 2013-14.
Interest, bonuses and dividends received are free of income tax, although the 10% tax credit on dividends cannot be reclaimed (the tax credit will in any case be abolished from 6 April 2016). Gains are free of capital gains tax, although the benefit of capital losses is lost.
The tax advantages are obviously greater for people paying tax at the higher rates. For example, the best interest rate currently available (August 2015) for a fixed term cash ISA is around 2.50%, although rates are much lower for instant access accounts (around 1.60%). This is an effective gross rate of 4.17% for a higher rate taxpayer, and 4.55% for an additional rate taxpayer.
Funds can be withdrawn from ISAs at any time without the loss of tax relief, although the interest rate for cash ISAs can include a bonus that is only payable if the investment is left untouched – typically for 12 months. Where investment is made for a fixed period, withdrawals will normally result in the loss of interest and, in some cases, the only way to make a withdrawal is to close the account.
It is not necessary to declare income and gains received from ISAs on a self-assessment tax return. ISA income does not result in the loss of the personal allowance for those with income in excess of £100,000, and is also ignored for tax credit and universal credit purposes. It is also ignored when it comes to the child benefit income tax charge.
Only individuals can open ISAs (an ISA cannot be held jointly by spouses or civil partners, held on behalf of anybody else, or held in trust) and normally an individual must be resident in the UK. If someone goes to live abroad, then they can keep their existing ISAs, but cannot pay in any more money. ISAs cease to be tax-exempt from the date that an individual dies, and the tax exemption does not extend to inheritance tax – ISAs are included in the value of a person’s estate.
The minimum age limit for cash ISAs is 16 and for a stocks and shares ISA it is 18. However, if a parent contributes towards a cash ISA held by a child aged 16 or 17, then the income can potentially be taxed as the parent’s rather than being tax-free.
Junior ISAs can be opened by parents for children aged under 18 who do not have a child trust fund - most children born between 1 September 2002 and 2 January 2011 will have a child trust fund. However, since 6 April 2015, it has been possible to transfer the savings in a child trust fund to a junior ISA. A transfer will normally be beneficial given the better interest rates and lower fund charges on offer with junior ISAs.
Anyone can contribute towards a junior ISA, including parents, family members and friends. In the case of parents, the income is always treated as the child’s. No withdrawals are normally permitted until a child reaches 18, and at that age a junior ISA automatically converts to an adult ISA.
Each tax year, an individual can open one cash ISA and one stocks and shares ISA which do not need to be with the same provider. For 2015-16, the overall investment limit is £15,240, with this limit being completely flexible. A person could therefore invest £15,240 in a cash ISA, or £15,240 in a stocks and shares ISA, or in any combination of the two – such as £10,000 in a cash ISA and £5,240 in a stocks and shares ISA. The ISA investment limit increases each year in line with the consumer price index.
For junior ISAs, the overall investment limit for 2015-16 is £4,080, with this limit also being split between a cash junior ISA and a stocks and shares junior ISA as desired. However, it is only possible to hold one cash junior ISA and one stocks and shares junior ISA at any one time - it is not possible to open new accounts each year. Somewhat surprisingly, there is no interaction between junior ISA and adult ISA investment limits. Therefore, someone aged 16 or 17 can benefit from both the overall junior ISA limit of £4,080, and the cash ISA limit of £15,240.
The investment limits are currently once only – for example, if £15,240 is put into a cash ISA during 2015-16 and £2,000 subsequently withdrawn, it is not then possible to make any further investment during 2015-16. For cash ISAs (and cash held in a stocks and shares ISA) this rule will cease to apply from 6 April 2016. A person will then be able to withdraw money from their cash ISA and replace it in the same tax year without the replacement funds counting towards their investment limit. A cash ISA will therefore operate similar to a normal bank account, with the only restriction being that the account balance cannot exceed the investment limit at any point during the year.
Additional ISA allowance
Since 6 April 2015, a surviving spouse or civil partner can claim an additional ISA allowance equal to the ISA savings of their deceased partner. The allowance is available where the partner died on or after 3 December 2014.
The surviving spouse or civil partner is able to invest as much into their own ISA as the deceased partner used to have invested, with this investment in addition to the normal annual investment limit. For example, if someone died with ISA savings of £60,000, then their spouse or civil partner is able to invest £60,000 into their own ISA in addition to the normal limit of £15,240.
It does not matter if the surviving spouse or civil partner actually inherits the deceased partner’s ISA savings, and no other beneficiary is entitled to the additional allowance even if they do inherit the ISA savings.
The investment time limit for the additional ISA investment is 180 days after the deceased’s estate is distributed (or for cash ISAs, up to three years from the date of death, if later). The investment can be with any ISA provider that will accept the subscription.
Help to Buy ISA
The Help to Buy ISA is available from 1 December 2015 for first-time property buyers. The Government will add a 25% bonus when the Help to Buy ISA savings are used to purchase a property, with the bonus applied to both the amount invested and the accumulated interest. The cost of the property purchased cannot exceed £250,000 (£450,000 in London).
The Help to Buy ISA can be opened with an initial deposit of £1,000, with subsequent monthly savings restricted to £200. The maximum Government bonus is £3,000. Since a couple purchasing together can both qualify, Help to Buy ISA savings of £30,000 ((£12,000 plus £3,000 bonus) x 2) could be available towards a house deposit. Given current interest rates, it will take around four and a half years to build up the £12,000 of savings necessary to qualify for the maximum bonus.
It is not possible to save in a normal cash ISA at the same time as investing in a Help to Buy ISA, but the maximum amount can still be invested in a stocks and shares ISA.
Innovative Finance ISA
An Innovative Finance ISA will be introduced from 6 April 2016 in order to bring peer-to-peer lending into the ISA net. Peer-to-peer lending is where lenders are matched with borrowers via an online platform. Although there can be more risk compared to normal cash savings, returns of 5% or 6% are typically available for longer term lending.
A few pioneering peer-to-peer products qualifying for inclusion within a stocks and shares ISA have already been launched.
The investment in a cash ISA is normally as a bank or building society deposit, although NS&I also offers a direct cash ISA.
Within a stocks and shares ISA, it is possible to hold any shares listed on a recognised stock exchange anywhere in the world, government and corporate bonds, unit trusts, open ended investment companies (OEICS), investment trusts, shares listed on the alternative investment market (AIM), securities issued by companies admitted to trading on certain small and medium size enterprise markets, core capital deferred shares issued by building societies (a form of equity which can be issued by mutual societies) and securities and shares issued by housing associations and other co-operative or community benefit societies, but not unquoted shares, options or futures.
The Government is consulting on whether to extend the list of permitted investments to include debt securities and equity offered via a crowdfunded platform.
Many ISA providers only offer a limited choice of investment funds – often just the funds managed by the provider itself. To have access to the full range of qualifying investments, it will probably be necessary to have a self-select ISA with a stockbroker, and even then the choice may be restricted, for example, to just FTSE 350 companies.
Subject to certain conditions, shares can be transferred into an ISA from an HMRC approved employee share scheme, but it is not possible to transfer windfall shares or inherited shares because subscriptions have to be in the form of cash. It is also possible to hold cash and certain life assurance policies within a stocks and shares ISA.
With minor exceptions, the same range of investments are permitted in cash junior ISAs and stocks and shares junior ISAs.
All types of transfer are permitted:
- Money in an existing cash ISA can be transferred to a cash ISA with another provider. This may be to obtain a better rate of interest or maybe to consolidate various old ISAs into just one account. Alternatively, the transfer can be to a stocks and shares ISA either with the same provider or a different one.
- Investments in a stocks and shares ISA can be transferred to another stocks and shares ISA with another provider (assuming the new provider will accept the investments held within the existing ISA). Alternatively, the transfer can be to a cash ISA with either the same provider or a different one.
Where a transfer is in respect of savings for previous years, then a partial transfer is permitted. However, the whole amount must be transferred if it is a transfer of current year savings. When swapping ISA providers the transfer must be directly between the respective ISA managers. If an ISA is closed and then reinvested, then it will use up the investment limit for the current year, whereas a transfer does not affect the investment limit.
The rules are essentially the same for junior ISAs. However, when making transfers the restriction that only one account of each type can be held at any one time must be complied with – so if money in an existing cash junior ISA is transferred to a new cash junior ISA, all of the funds in the existing account must be transferred.
The right choice?
There are normally no charges involved with a cash ISA, but an individual must be careful and not just focus on the tax saving. A survey in 2011 found that the Halifax was paying gross interest of 3.35% on its one year fixed rate bond, but just 2.00% on a similar cash ISA. Even higher rate taxpayers would have been marginally better off with the non-ISA account (3.35% less 40% income tax is a net return of 2.01%). A review of savings accounts currently offered by some of the major high street banks and building societies indicates that this is no longer the case. Generally, cash ISAs are probably the right choice for everyone except for non-taxpayers, although it pays to shop around as interest rates can vary between providers.
However, the introduction of the tax-free personal savings allowance from 6 April 2016 will make cash ISAs redundant for many small savers. Savings income of up to £1,000 each year will be exempt for basic rate taxpayers, with a £500 exemption for higher rate taxpayers. With savings rates of just over 2%, a basic rate taxpayer will be able to have around £45,000 invested before having to worry about an account’s tax status. Higher and additional rate taxpayers should still find cash ISAs valuable, as will anyone who is aiming to build up substantial long-term savings.
It can be much more difficult in deciding whether a stocks and shares ISA is the right choice. Charges will vary according to the type of investment and also between providers. However, annual management fees for self-select stocks and shares ISAs are now extremely competitive, and for many fund type ISAs the charges are no different to if the investment was made outside of a ISA.
As far as income tax is concerned, there is no benefit to receiving dividends within a stocks and shares ISA for basic rate taxpayers as the tax credit cannot be reclaimed. The introduction of a £5,000 annual dividend allowance from 6 April 2016 will also remove the advantage of receiving dividends within an ISA for many higher and additional rate taxpayers.
There is no capital gains tax benefit to a stocks and shares ISA if gains would otherwise be covered by the annual exempt amount (currently £11,100). A stocks and shares ISA is therefore most appropriate for higher and additional rate taxpayers who already have sufficient gains to make use of the annual exempt amount. Such taxpayers will currently avoid the higher or additional rate income tax liability on dividend income, and they will also save capital gains tax at the higher rate of 28%.