What is an ISA?
What You Need to Know
- ISAs allow you to earn interest on your savings, tax free
- There are two main types of ISA, cash and shares based ISAs
- In both cases you can only pay in a limited amount each year, though how you divide up your savings is up to you
- From 6th April 2015, you are allowed to save up to £15,240 in ISAs each tax year. The limit on a junior ISA is £4,080.
- The limit on how much you can deposit in an ISA does not take any withdrawals you might make into account, so it can be best not to move money in and out too frequently
- As of 3 December 2014, when an ISA holder passes away, their surviving spouse or civil partner can now inherit their ISA tax benefits, and keep the amount of money they held in ISA’s tax free.
- Once you have an ISA, you do not have to stay with the same provider. If you're unhappy you can switch for a better interest rate
- Historically shares based ISAs have out performed their cash equivalents, though there is no guarantee this will always be the case
The two different types of ISA
Individual Savings Accounts (ISAs) are essentially a tax-free way of saving money. Your ISA account works in the same way as a normal savings account, except that you won’t have to pay tax on the interest you earn.
There are two types of ISAs; cash ISAs and stocks and shares ISAs. The differences between these are easy to understand:
- Cash ISAs: As the name suggests, cash ISAs are savings accounts that let you save your money free from income tax. The rate of return you will get on your savings will be known in advance, so it's important you shop around for the best possible deal.
- Stocks and Shares ISAs: A stocks and shares ISA is an account in which your money is invested rather than saved, usually in a pooled fund. Your returns will be protected from capital gains tax and higher rate tax payer's will also get relief from dividend income from share's based ISAs. Your returns will vary according to how well the fund into which they are invested performs: you could get a better rate of return than if you put your money in a cash ISA, or you could end up worse off.
How much can I save in an ISA?
Because the interest you earn on your savings is tax-free in an ISA, the government has set limits on how much money you can invest in each tax year.
As of 6th April 2015, the maximum amount you can save this way is £15,240. This figure is reviewed annually in the Budget. Recent changes mean that while in the past the rules meant you were allowed to save more in stocks and shares ISAs than in cash ISAs, you are now allowed to have any combination of cash and stocks and shares ISA’s you want so long as you don't exceed the £15,240 limit. So, you can put all the £15,240 in a cash ISA, all of it in a stocks and shares ISA or in a combination of both, the choice is yours. You are however only permitted to open one cash ISA and one stocks and shares ISA for each financial year.
This is what's known as a New ISA (NISA). NISAs are designed to be a lot simpler than old-fashioned ISAs as you don't have to worry so much about dividing your money up between cash savings and investments. You are still allowed to open up other NISA’s to transfer and existing old ISA accounts, opened before the new regime was introduced, into them.
But despite the rebranding, to make life easier for everyone, this type of savings vehicle will continue to be known simply as an ISA.
Note that any money put into an ISA from the start of the 2015/16 tax year (that is from 6 April 2015 to 5th April 2016) will count towards this £15,240 limit.
The other ISA product which is available is a Junior ISA. This is a tax free savings account available for children who are under 18 and who reside in the UK. Again there are Cash Junior ISA’s and Stocks and Shares Junior ISA’s available.
The annual savings limit for a Junior ISA as of 6th April is £4,080. Parents and Guardians are allowed to open Junior ISA’s and manage the accounts, but the money belongs to the child. THe child itself is allowed to control the account from the age of 16, but cannot withdraw money until they are 18.
It is important to note that Junior ISA’s cannot be held at the same time as a Child Trust Fund, but you can arrange for your Child Trust Fund to be transferred into a Junior ISA.
What happens if I take money out of my ISA?
The annual limit on ISAs refers to how much you can pay in rather than the actual balance of the account. This means that although you can take money out of your account and put cash back in, you can only deposit a maximum of £15,000 in any tax year.
For example, if you paid £2,000 into an ISA in May 2014 then took it out in June, you would still only be able to pay in a further £13,000 until the end of the tax year.
If you paid in your full ISA allowance in August 2014, after the new limit came into effect, then took £1,000 out the next month, you would still have used up your year’s allowance and would have to wait for the new tax year before you could pay any more money into your account.
The new tax year
Each year on 6 April, your tax-free ISA allowance starts all over again – regardless of how much money you’ve got in your account.
So if you already have paid in your ISA allowance from the last tax year, you would be able save another £15,240 when the new tax year starts. However, it's always worth keeping an eye on the financial news as the amount you can save tax-free is frequently adjusted, so be sure you stay up-to-date so that you don't miss out.
Again, it’s important to stress the fact that your annual limit refers to the amount of money you can pay in to your account over the course of a year, not the amount you can keep in the account altogether. You should also note than once the tax year ends, unused allowance can't be carried over.
Can I switch my cash ISA?
Yes. Many people stick with poor interest rates because they think that switching is too complicated. But switching your ISA can get you a much better return on your savings.
The main thing to remember is that you should arrange the switch with your new ISA provider, who will be able to transfer your savings for you. Don’t simply take the money out to move it yourself – you’ll lose your tax relief if you do this.
Inheriting an ISA
As of 3 December 2014, if your spouse or civil partner passes away, you are allowed to inherit their ISA’s. This means that the amount of money they held in tax free savings, whether cash ISA’s or stocks and shares ISAs, is added to your total tax free savings allowance.
For example, if your husband or wife held ISA’s to the value of £45,000 when they died, you are entitled to an additional ISA allowance of £45,000, on top of your annual allowance of £15,240.
This allowance is not dependent on you being left your partners ISA assets in their will either. If your husband has left his ISA’s to someone else, you are still entitled to this additional allowance. No-one apart from the deceased spouse or civil partner can claim it however.
Where a cash subscription is paid, the spouse has 3 years from the date of death to use this and it can be paid in addition to their ISA allowance.
How much tax will I save?
The amount of tax you would normally pay on your savings interest depends on how much income tax you pay.
- If you pay tax at the basic rate, you would usually pay 20% on your savings interest
- If you pay tax at the higher rate, you would usually pay 40% on your savings interest
- If you pay the “saving rate” of tax for savings, you would usually pay 10% on your savings interest.
So by keeping your savings in a cash ISA, you could save 10%, 20% or even 40% on the interest you earn.
Shopping around for the best ISA deals
Savings accounts aren’t all about how much you can earn – you need to think about what kind of saver you are as well. Think about whether you want instant access or an annual interest payment – which could get you a higher rate. You might want to manage your account online or have an ISA at a local bank. These extra benefits are important as often interest rates are fairly uniform across the various UK high street banks.
Comparing ISAs deals online allows you to look at all the options and find the best possible return on your cash.
- The gov.uk website has more details about your ISA entitlements including the latest annual limits.
- Barclays offers a guide explaining how the new ISA rules of 2014 may affect their savers. Check that out here.
- Fancy trying to make more of your money? Read our guide with everything you need to know about investing in stocks and shares: