ISAs or Individual Savings Accounts have become one of the foundations of saving and investment in the UK. One of the key reasons for this is the way that they make those savings and investments more rewarding, because they are exempt from tax. Your cash can grow faster while it is in your ISA, because the taxman will not take a share of the interest it earns, and there will be no income or capital gains tax to pay when the time comes to draw it out.
It is hardly surprising that most financial experts suggest that anyone who wants to grow their wealth should start with an ISA. In fact, the advantages of tax-free savings - and consequently the popularity of ISAs - are so great that the government has always had to set limits on how much you can put into your ISA account each year, to avoid the treasury running short of the revenue it needs.
This limit is known as the ISA allowance.
Everyone has the same allowance, each tax year, which usually runs from the 6th April to the 5th April the following year, and when each new tax year starts you will have a brand-new ISA allowance.
If you do not use all your ISA allowance before the end of the tax year it will be gone for good. You cannot carry forward part of your ISA allowance from one year to the next. So it may make sense to put as much as you can behind the protective walls of your ISA each year.
So, the 2019/20 ISA tax year allowance is £20,000, for anyone aged over 18, the same as it as it was last year. But whatever level the Chancellor sets in the budget, you need to be careful how and where you use your ISA allowance, because it is simply too valuable to waste.
What are the ISA rules?
You do not have to invest the full £20,000 ISA – you can invest any amount up to this figure.
So, if you want to put it all into a Cash ISA, or all into a Stocks and Shares ISA, you can. However, many people like to spread, or diversify their investments. Fortunately, you can subscribe to more than one type of ISA during the same tax year and invest at the level you wish, although the ISA Allowance does not change, and if you do have two or more different ISAs, your total contribution in any given year must not exceed £20,000.
Despite the restrictions, there is no actual limit on the amount you can have in your ISA accounts. So you can potentially build up a very large ISA holding by maximising the use of your annual ISA investment allowance each year.
Things can become a little more complicated if you look at some other types of ISAs. For example, if you choose a Help to Buy ISA you can save an initial deposit of up to £1,200, and then save up to a maximum allowance of £200 a month. In a Lifetime ISA your maximum allowance is £4,000 a year. So although, you can only put £4,000 in the Lifetime ISA each year, you still have the remaining £16,000 from your ISA allowance which you can put into other types of ISA.
Junior ISAs give adults a tax-efficient way to save money on behalf of a child and have an allowance of £4,368.
The overall total you can invest in all your ISAs is still fixed at £20,000.
Remember, if you wish, you can invest the full £20,000 ISA allowance into an Innovative Finance ISA.
The other ISA rules
The annual allowance is the most important restriction on ISAs, but there are some other rules that you need to be aware of.
Firstly, you need to be a UK resident aged 16 or over to open a Cash ISA, or aged 18 or over to open a Stocks & Shares ISA or Innovative Finance ISA. You can't open an account with someone else, but remember, even if you are a couple you both get your own ISA allowance and can therefore have one each
You can’t open an ISA on behalf of someone else – unless it is a Junior ISA, on behalf of a child who is under 16.
Finally, you can only subscribe to one of each type of ISA in any one tax year, although you can hold multiple ISAs that you have funded in previous years.
What is a flexible ISA?
There are also some rules about taking money out of an ISA. Contrary to common belief, there is no minimum time that an ISA needs to be held to enjoy the tax-free benefits. Providing the rules of your ISA provider allow it, you can have full access to your money instantly at any time. If you withdraw some you will not lose the tax benefits on the rest of your savings that remain within the ISA.
However, what happens after the money is withdrawn will depend on the type of ISA it is. If it's a non-flexible cash ISA, once the money is withdrawn it can't be returned. So if you pay in £20,000, and discover you need £5,000 fast, you can withdraw it, but you will not be able to pay any more in to your ISA before the end of the tax year.
There may be a fee for a withdrawal, but the £5,000, or rather the interest it earned while it was in your ISA, will not be taxed.
However, with a flexible ISA, such as a RateSetter Innovative Finance ISA, you have the freedom to withdraw the £5,000 and pay it back in again, as long as you do not run over your annual allowance. You can only pay it back again within that tax year.
If you have an ISA that pays interest annually and close it before the interest is due to be paid, you will still get the accrued interest - but less any fees for closure or withdrawal.
How do ISA transfers affect your allowance?
Once your money is inside an ISA, you can switch ISA providers and even the type you hold. You might want to do this to get the best rates on a Cash ISA or swap a Cash ISA holding for a Stocks and Shares ISA or an Innovative Finance ISA. Transferring an ISA must follow a set process to avoid losing your ISA entitlement. However all you will need to do is fill out a transfer form, and your new provider should then sort it all out for you.
Some providers may charge you a fee for withdrawing your money or leaving them.
Finally, ISAs do not lose their tax-efficient status if they are left to a spouse. They continue to for the rest of the surviving spouse's lifetime, which means they will be able to receive interest or returns tax-free. However, they will lose their tax status if passed on to descendants.
Please note that tax treatment depends on individual circumstances and may be subject to change in the future. Capital at risk. No FSCS protection.