ISAs – a complete guide

ISAs have had a shake up in the last few years, giving you more choice and potential rewards. To help you understand the options available, below you’ll find details on the different types of ISA, how they work and key points to be aware of. Always remember that tax rules depend on your individual circumstances and may change in the future.

What is an ISA?

ISA stands for Individual Savings Account. They allow you to earn interest on your savings or investments tax-free. The amount you can put into your ISA is capped for each tax year, for 2018/19 and 2019/20 it’s £20,000. This is called your ISA allowance.

You can choose to split your ISA allowance across different ISAs, or put it all in one. How you choose to do this can make a big difference to your earnings.

What types of ISA are there?

There is a variety of ISAs to suit different risk appetites and life stages. You can choose from a Cash ISA, Stocks & Shares ISA, Innovative Finance ISA (IFISA), Lifetime ISA (LISA) and Help to Buy ISA. There’s also a Junior ISA to help you save for the kids.

You can only pay into one of each type of ISA in any tax year. Each has different benefits, so it’s important to understand how they work.

Cash ISA

A Cash ISA works like a savings account, only all the interest you earn is completely tax-free. As with savings accounts, there’s a whole host of Cash ISA providers and options out there, such as instant access, fixed-rate or regular savers. Most are free to set up, but some may charge to withdraw.

Although you may earn a lower interest rate with a Cash ISA than a Stocks & Shares ISA or Innovative Finance ISA, they are very low risk. Your money is also protected by the Financial Services Compensation Scheme, which will compensate you up to £85,000 if you lose your money. However, if the interest rate offered is below inflation, you could be losing out in real terms.

Stocks & Shares ISA

You can also use an ISA to earn tax-free interest on investments. These Stocks & Shares ISAs will normally be managed using an app, online platform, broker or fund manager.

Your money could be invested in shares in public companies, bonds (essentially a loan to a company or government) or funds (a mixture of investments pooled together).

These types of investment can give you higher returns than you’d get with a Cash ISA, but they carry more risk. Although the interest is tax-free, your investment could go down as well as up.

There are often more fees associated with a Stocks & Shares ISA as well. Providers may charge you for opening an ISA, changing investments, withdrawing or transfering to another ISA provider.

Innovative Finance ISA

Innovative Finance ISAs allow you to earn tax-free interest by lending to people or businesses. There are a variety of online providers (often known as peer-to-peer lenders or lending platforms) that will focus on different groups. Some only lend to individuals, others to property developers, and some like Funding Circle that lend to small UK businesses.

As you’re lending your money, there’s a risk that the loans won’t be repaid. Providers mitigate this risk in different ways, such as spreading your funds across multiple loans.

As you’re lending your money, there’s a risk that the loans won’t be repaid. Providers mitigate this risk in different ways, such as spreading your funds across multiple loans.

Consequently, Innovative Finance ISAs typically sit somewhere between Cash ISAs and Stocks & Shares ISAs. They typically offer better returns than Cash ISAs and savings, but are more stable than playing the stock market.

With the Funding Circle ISA you could earn a projected return of 6-7% per year*. Find out more. Capital at risk.

Help to buy ISA

Help to buy ISAs are a type of Cash ISA made for first-time house buyers. You can save £1,200 in the first month, then £200 per month from then on. When you’re ready to buy your property, the Government will then add 25% as a bonus (up to £3,000).

As they are a type of Cash ISA, you can’t pay into both a Cash ISA and a Help to buy ISA in the same tax year. If you’ve opened your Cash ISA this year, you can transfer the funds to your Help to buy ISA. If you have more than £1,200 in there, you can transfer the rest elsewhere.

Lifetime ISA

Like the Help to buy ISA, a Lifetime ISA can help you at important life stages. It can also help you buy your first home, or you can keep it open and use it for retirement.

You can deposit up to £4,000 per year and get a 25% bonus from the state. The bonus is paid monthly (if you make a deposit that month), and once it’s in your account it counts as your money, so you can earn interest on it too. You have to be between 18-39 to open one, and you’ll get contributions up to the age of 50.

If, however, you take the money out for anything other than buying your first home or retirement, there is a penalty of 25%. That leaves you around 6% down overall. It sounds counterintuitive, but here’s an example to show how it works:

£4,000 + 25% = £5,000

£5,000 – 25% = £3,750

How can I use my ISA allowance?

The ISA allowance is set every year. It’s risen from £7,000 in 1999 to £20,000 in 2019. While there used to be rules on how you can split your ISA allowance, now there’s more freedom.

As mentioned above, there are limits to how much you can put in a Lifetime ISA or Help to buy ISA. Aside from that you can choose to spread your £20,000 however you’d like to. You can put it all in one ISA, or spread it among a few.

Remember, if you choose to spread it out, it’s your responsibility to make sure you don’t go over your £20,000 ISA allowance in total. Providers will usually make sure you don’t exceed the limit in any one account, but they won’t know what ISAs you have elsewhere.

Any interest also won’t count towards your personal savings allowance. This is another allowance which lets you earn £1,000 of interest on savings each year without paying tax (£500 for higher tax rate payers). So if you have a lot of savings earning interest, an ISA will help you keep more of it tax-free.  

How do I get my money out of an ISA?

The rules for taking money out of your ISA depend on the type and provider you have. There is no set time period you need to start enjoying the tax-free benefits. However, some products may have fees for withdrawing or closing your account early.

Unless you have a flexible ISA, once you’ve taken out funds you can’t put them back in.

What is a flexible ISA?

With a flexible ISA, you can take money out and replace it within the same tax year without it affecting your tax-free ISA allowance. Here’s some examples to show how it works:

Judy has a flexible ISA. She’s paid in £20,000 already this year, using her whole allowance. She takes out £10,000 to buy a car, but because she has a flexible ISA she can pay the £10,000 back in before the April 5th deadline.

John has a non-flexible ISA. He’s also paid in £20,000 this year. He takes out £8,000 to redo his kitchen, but he can’t pay in any more until the next tax year.

Tina also has a non-flexible ISA. She’s paid in £5,000 this year, leaving £15,000 of her allowance left. She takes out £2,000 for a family holiday, but can still only pay £15,000 back in.

Whether an ISA is flexible or not depends on which ISA you have. Cash ISAs, Innovative Finance ISAs and cash in a Stocks & Shares ISA can all be flexible, but it depends on the provider.

Help to buy ISAs, Lifetime ISAs and Junior ISAs are not flexible.

When is the deadline for using my ISA allowance?

You must use your ISA allowance by April 5th to get the tax benefit for that year. The allowance does not roll over, so you will lose it if you don’t take advantage. From April 6th onwards it will be a new tax year with a new ISA allowance that you can use. The previous year’s allowance, however, will be gone.

Who is eligible for an ISA?

To be eligible for an ISA, you must:

  • Be 16 or over (18 or over for Innovative Finance ISA and Stocks & Shares ISA)
  • Live in the UK
  • Have a national insurance number

You can only take out an ISA in your own name. Joint ISAs with a friend, partner or relative aren’t allowed.

Can I transfer ISAs?

You can transfer ISAs from both the current tax year and previous years to a new provider. Just like your bank account or household bills, switching providers can help you get the best rates.

When transferring ISAs there are two important points to remember:

1 – Don’t withdraw the money yourself – speak to the new provider about a transfer

Transferring an ISA is not as simple as withdrawing from your bank account and depositing somewhere new. If you withdraw the money yourself, you can lose your tax benefit. Instead, speak to your new provider and ask them for an ISA transfer form. Normally they will then arrange the transfer for you.

As mentioned above, Stocks & Shares ISAs often charge a fee for transfering, withdrawing or closing an ISA.

2 – You can only pay into one of each type of ISA in any tax year

If you want to transfer a ISA from the current tax year, you’ll have to move all of it to the new provider. However, for ISAs from previous years, you can either move them all into one or split them across several providers.

What is a Junior ISA?

If your child is under 16, you can open a Junior ISA (JISA) for them instead. They only get an allowance of £4,260 at the moment, but if you open one when they’re born they’ve got plenty of years to rack up interest. You have a choice of Cash or Stocks & Shares, and you can divide the allowance between the two.

Although it’s in their name, the ISA is opened and managed by you. They can take over when they reach 16, but they can’t touch the cash until 18. Once they turn 18 though it’s their money to do want they want with.

The Funding Circle ISA

The Funding Circle ISA is an Innovative Finance ISA. By using the simple online platform, you can quickly lend to hundreds of small UK businesses. They get the money to grow and create jobs, and you can earn interest as they pay you back each month.

You can earn a projected return of 6-7% per year*. It’s a flexible ISA, so you can take money out without losing your tax-free allowance, and you can transfer ISAs from other providers.

Find out more about the Funding Circle ISA here.

By lending to businesses your capital is at risk. Tax rules depend on your individual circumstances and may change. Not covered by the Financial Services Compensation Scheme.

*The rates shown are the annual projected returns, after fees and bad debts but before tax, that a diversified investor could earn with the Balanced lending option. Your actual return may be higher or lower than projected, for example due to the performance of the individual loans your funds are matched with, or a change in macroeconomic conditions.

The information and views contained here are provided solely for informational purposes and should not be construed as legal, tax, regulatory, accounting or investment advice, or as a recommendation or an offer or invitation by Funding Circle.

To the extent permitted by law, Funding Circle does not accept any liability for any loss or damage which may arise directly or indirectly from the use of, or reliance on, such information contained here. If you have any questions, please speak to your professional adviser or seek independent specialist advice.

Rob McCorquodale