What’s your ISA fit?
ISAs are a fantastic vehicle for long-term savings thanks to generous tax-saving features
When saving into an ISA you don’t pay any tax on the money in your account, or any income or capital gains tax on the interest you earn. However, there are a few rules you should be aware of when using them.
ISA stands for Individual Savings Account and was introduced over 21 years ago as a replacement for two products, TESSA (Tax Exempt Special Savings Account) and PEP (Personal Equity Plan).
The ISA was conceived by the government as a beautifully simple way to encourage normal people to save in a tax-free way. It has been tinkered with little in that time, as well as receiving regular changes to its annual limits.
There are currently several varieties of ISA, including:
- Stocks and Shares ISA
- Cash ISA
- Lifetime ISA
- Junior ISA
- Help to Buy ISA
All ISAs are pretty straightforward to use, although the Lifetime ISA (LISA) has a few strings to be aware of. When choosing an ISA to save your money, knowing the rules of how it works and the limits to how much you can save will help select the best one for your needs.
The Help to Buy ISA was discontinued in 2019, replaced by the LISA, so while no one can open a new one, some people will still hold them. The Junior ISA (JISA) is only available to children aged under 18, although it needs to be opened by somebody over 16.
The other key distinction with an ISA is whether you invest in cash, as with a normal savings account, or in a stock market linked investment, hence the distinction between a cash ISA and stocks and shares ISA. Confusingly, the LISA and JISA allow you to invest in either cash or stocks and shares.
Probably the first and perhaps most important decision to make when choosing an ISA is whether you want a cash ISA, where your money earns interest like a normal savings account, but all your money is secure, or a stock market linked variety, which is an investment product with the potential for your money to grow more, but, as with any investment, there is more risk.
The next thing to consider with an ISA, is the annual limit, which currently stands at £20,000 per tax year for most ISAs. This means that between 6 April of one year and 5 April for the next, you are allowed to save a maximum total of £20,000. You can hold either a cash ISA or a stocks and shares ISA, or indeed one of each, but the maximum total across all your ISAs is £20,000.
Again, the LISA is an exception because it has a maximum limit of £4,000 per year, and you also can’t open one if you’re 40 and over, but more about that later.
For the purposes of this article we’re going to focus on the two ISA types EQi provides: the stocks and shares ISA (SSISA) and the LISA.
Stocks and shares ISA
The SSISA is the simplest of the ISAs EQi offers. You can save into it up to £20,000 a year, so long as you don’t go above the maximum £20,000 total across all the ISAs you hold. Within the SSISA “wrapper”, as it is sometimes called, different providers have a choice of ways of investing your money. The EQi ISA is also a ‘flexible’ ISA which means you can take money out during a tax year if you need to, and pay it back in again without it counting against your allowance.
With EQi for example, you are able to buy company stocks, investment funds, or exchange traded funds (ETFs) from a wide variety of markets.
As with all ISAs, any money you put into the SSISA and any profit you earn from the investment is exempt from any kind of tax treatment by the government. It is totally untouchable. You do not even need to produce information about how much you have saved or the amount earned from your ISA on a tax return, if you have to complete one.
While some commentators routinely debate the future of ISAs, it is fairly widely recognised that most governments would find it politically impossible to change the tax status of the ISA.
The only other significant limit for SSISAs is the age at which you can open one. While you can open a cash ISA at age 16, you must be at least 18 to hold a SSISA, but there is no upper age limit. You must be a resident in the UK (nationality is irrelevant) or a Crown servant (diplomatic or overseas civil service, for example), or their spouse or civil partner if you do not live in the UK.
The LISA is a newer ISA variety, introduced in 2016 in part to replace the Help to Buy ISA, and is available as either a cash or stocks and shares version.
The annual limit is lower than a SSISA, at £4,000, but the big attraction of a LISA is that the government will give you a 25% bonus. This means that if you save the maximum £4,000 in the tax year, you will receive an extra £1,000 bonus on top of anything you’ve earned.
The LISA is designed for two specific purposes:
- Saving to buy a house
- Saving for retirement
Anyone aged 18 to 39 can open a LISA, but there are restrictions for how you can access the money. Currently you can continue paying into a LISA and receive the government bonus until you turn 50, unless of course you use it for buying a house. With an EQi LISA the money you save can be invested in the stock market, just like the SSISA.
If you use a LISA to save towards buying a house, there are a few rules too:
- the property must be your first home and cost £450,000 or less
- you must buy the property at least 12 months after you first pay into the LISA
- you must use a conveyancer or solicitor to act for you in the purchase. Your LISA provider will pay them directly
- you must be buying a house with a mortgage
If you already have a Help to Buy ISA, and aren’t ready to buy a house, you can transfer this to a LISA and therefore benefit from the 25% government bonus.
If you’re saving into a LISA for your retirement, you should wait until you turn 60 before withdrawing your money. But remember, you can’t contribute fresh funds into the LISA after the age of 50. If you are considering using a LISA for your retirement instead of a pension, it’s worth talking to a financial adviser first to see which is the best option for you.
It is important to remember that the government bonus is contingent on you using the savings to pay for a house deposit, or for your retirement when you reach 60. If you take the money out for any other reason, you will lose the bonus and face a charge of 25% on the whole amount – which means you may end up with less money than you started with.
For example, if you pay in £800 to your account, the government will top this up with a 25% bonus worth £200, making a total of £1,000 in your LISA. If you then decide to take all your money out early, the government will charge you a penalty of 25% of the whole amount of £1,000, which is £250. This means you’ll end up with only £750 back – effectively a £50 charge.
However, at the time of writing there is a big caveat to this rule. Because of the coronavirus crisis, the government has relaxed the penalty for people withdrawing their money from a LISA until 6 April 2021. If you withdraw your money before then, you will only be charged 20% of the whole amount, so you will simply lose the bonus and not face a penalty on top.
This might seem like a long list of rules and caveats for the LISA, but you must not forget that the 25% bonus is extremely generous. If your goal is to buy a house or save for retirement, it is a very good option to consider.
Whatever ISA you choose, remember the taxman can’t touch it, which makes it a very appealing proposition for your savings and investment portfolio.
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