The ISA (individual savings account) is one of the most potent “vehicles” available for tax-efficient saving and investing. Yet, how do you confidently navigate the various different types of ISA? What are the pitfalls and opportunities to look out for?
Below, our Carlisle financial planners offer an updated guide to building an ISA strategy in 2024-25. We include an overview of how different ISAs operate, their key features, and how each can be integrated into a wider financial plan.
We hope these insights are helpful. Please contact us for more information or to speak with a financial adviser:
t: 01228 210 137`
e: [email protected]
What are ISAs?
ISAs were introduced by (then) Chancellor Gordon Brown under New Labour in 1999. Essentially replacing personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs), they were intended to encourage saving and investing among the general public by offering numerous tax-saving benefits.
Notably, any funds held inside an ISA are completely free of tax on interest, dividends, and capital gains. An individual can contribute up to £20,000 to their ISAs, in total, each tax year. Any unused ISA allowance is lost when the new tax year starts on 6 April.
A person can save into multiple different types of ISAs in a tax-year. For example, a person could save £10,000 into a Cash ISA, and £10,000 into a Stocks and Shares ISA, in the same tax-year. The only limit is the £20,000 annual amount which is measured across all ISA types. One often overlooked aspect of ISA saving is that, unless your ISA is a ‘flexible’ ISA, any funds which are withdrawn from the ISA cannot be put back in (unless there is sufficient remaining ISA allowance).
The Cash ISA
Perhaps the most well-known ISA type, the Cash ISA operates similarly to a regular savings account. It acts as a storage space for cash, except any interest earned will be tax-free (not counting towards the saver’s Personal Savings Allowance).
A cash ISA is often useful as a “parking area” for emergency savings – e.g. 3-6 months’ worth of living costs. The funds can sit there earning interest (tax-free) and are easily accessible if a sudden, unexpected expense arrives, such as repairing a broken boiler.
However, interest rates in Cash ISAs are generally not much better than those offered by regular savings accounts. Indeed, banks sometimes offer lower rates to Cash ISA savers given the tax-free nature of the returns. Moreover, the interest earned will usually not keep up with inflation (thus eroding the “spending power” of the savings over time).
The Stocks & Shares ISA
Similar to a general investment account (GIA), a stocks and shares ISA lets the individual put their money into various assets, such as equities, bonds, and REITs (real estate investment trusts). However, any capital gains and dividends earned will be tax-free.
A stocks & shares ISA can be a powerful way to generate tax-efficient returns for specific financial goals – e.g. early retirement, or non-retirement goals, such as buying a house in the distant future.
While ISAs are an excellent vehicle for tax-efficient savings, they do have certain disadvantages. For example, ISAs are not automatically exempt from inheritance tax (IHT), and the range of investments may not be as wide as other investment “vehicles”, such as a self-invested personal pension (SIPP).
Lifetime ISA
This is a bit of a strange ISA, but it can be very useful. An individual can contribute up to £4,000 to their Lifetime ISA (LISA) each tax year. The government will “top up” the contributions by 25%, up to a maximum of £1,000 per year.
This bonus is designed to encourage saving for two specific objectives, buying your first home and retirement. Withdrawals for these reasons are free of penalty and the LISA can generate significant additional returns from the government contributions. Withdrawals for any other reason incur a penalty of 25%, essentially repaying the government bonus and more.
However, the LISA does have downsides compared to its main rival, the pension. The latter allows funds to be passed down to beneficiaries free of IHT. It also benefits from “tax relief” when the scheme member makes contributions, whilst the LISA does not.
The Junior ISA
Those with children may wish to help them save towards their own financial goals while still young. Here, the Junior ISA can help. Parents or guardians manage the Junior ISA until the child turns 18. At this point, the child takes over.
Up to £9,000 can be contributed to a Junior ISA each tax year. One advantage is that a Junior ISA can be a “cash” version or a “stocks & shares” version, letting parents choose the best strategy for their child. However, you have no control over the funds once your child turns 18.
At this stage, your child may choose not to use the funds as you intended!
Building a robust ISA strategy
The best choice of ISA(s) depends heavily on your unique financial goals, attitude to risk, financial situation, investment/saving horizon, and other key personal factors.
For instance, an older person who is focusing primarily on their estate plan (to pass down wealth tax-efficiently) may not wish to open any ISAs. Rather, they may wish to focus on spending these funds instead of those in their pensions due to the IHT advantages of the latter.
By contrast, a young person wishing to get onto the property ladder will likely benefit from focusing first on their Lifetime ISA (to get the 25% government “bonus”). Other ISA types could be considered to make use of their remaining ISA allowance after the £4,000 annual limit is maximised.
A third individual may already have a mortgage, a spouse, and young children. Their goal is to build up their pension and other investments to try and retire early, in their 50s. Here, a stocks & shares ISA could be useful since the funds could be accessed earlier than those in the individual’s pensions (which are barred by the Normal Minimum Pension Age).
The above are only examples. A financial adviser can help you determine the best strategy for your tax-efficient savings to help meet your individual objectives.
Invitation
If you would like to discuss your financial plan and investment strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.