Chancellor Gordon Brown first announced the Individual Savings Account (ISA) in 1999. Interestingly, the idea was initially met with criticism by many and even branded a “colossal failure” by Labour MP Quentin Davies.
Despite this frosty reception, the ISA has since become one of the most popular saving and investment vehicles in the UK, and the government has introduced several different types over the last 20 years.
Figures from the UK government show that in the 2021/22 tax year, 11.8 million adults subscribed to an ISA, collectively paying in £66.9 billion.
ISAs have become popular because they offer significant tax benefits. If you take advantage of this tax wrapper, you could grow your wealth faster and mitigate a large tax bill.
However, some people have criticised the ISA landscape, calling it too complex. According to Professional Adviser, 70% of Brits surveyed were familiar with ISAs but fewer than half could correctly identify the main types of investment ISA. Additionally, less than a third of people knew what their annual ISA allowance was.
It’s important to understand some of the different types of ISAs that might support various areas of your financial plan if you want to make the most of this tax-efficient savings and investment vehicle.
You can contribute up to £20,000 across all your ISAs in the 2023/24 tax year
One of the main benefits of an ISA is that you don’t pay Income Tax, Capital Gains Tax (CGT), or Dividend Tax on any interest or returns you generate from savings and investments held in an ISA wrapper.
However, there is a limit on the amount you can contribute to ISAs each tax year.
In 2023/24, you can put up to £20,000 across all your ISAs. You can spread this allowance across different types of ISA, and you can contribute to one of each type.
For example, while you could pay into one Cash ISA and one Stocks and Shares ISA, you couldn’t pay into two different Cash ISAs in the same tax year.
The rules are different for a Lifetime ISA – more on this later.
Using your full ISA allowance each year can help you maximise the tax benefits you receive and build your wealth faster. However, to get the most out of your ISAs, it’s important to use the right type – this will depend on your financial goals.
Read on to learn about some of the different ISAs and how you could benefit from using them.
1. Cash ISA
A Cash ISA is perhaps the simplest type of ISA available. It works in much the same way as a standard cash savings account – you make deposits and may generate interest on the funds in the ISA.
One of the main benefits of a Cash ISA is that you don’t pay tax on any interest you accrue.
Conversely, in a non-ISA savings account, you may pay Income Tax on any interest that exceeds your Personal Savings Allowance (PSA). In 2023/24, this stands at:
- £1,000 for basic-rate taxpayers
- £500 for higher-rate taxpayers
- £0 for additional-rate taxpayers.
As such, if you’re a higher-rate taxpayer, you could only hold £10,000 in a normal savings account with a 5% interest rate without exceeding your PSA and triggering a tax charge.
Saving in a Cash ISA could help you reduce tax on your interest and retain more of your wealth.
That said, if you hold large amounts of your wealth in cash, it’s important to consider the effects of inflation. If the interest rate on your Cash ISA is lower than the rate of inflation, your savings could lose their spending power.
So, a Cash ISA may be useful for an emergency fund or saving for short-term goals, such as a holiday or a new car. Yet, if you want to grow your wealth over a long-term horizon, you may decide to use a different type of ISA.
2. Stocks and Shares ISA
Investing may be an effective way to generate long-term growth that outpaces inflation, so your wealth retains its value in real terms.
You can invest in a range of asset classes through a Stocks and Shares ISA including:
- Individual stocks and shares
- Unit trusts
- Investments trusts
- Exchange-Traded Funds
- Corporate and government bonds.
You do not pay Dividend Tax or CGT on any returns or profits from investments in a Stocks and Shares ISA.
Conversely, if you invest in a General Investment Account (GIA), you may pay Dividend Tax on any dividend income that exceeds your “Dividend Allowance”. This stands at £1,000 in 2023/24.
You may also pay Capital Gains Tax (CGT) on profits that exceed your “Annual Exempt Amount” – £6,000 in 2023/24 – when selling or transferring ownership of investments.
As such, it may be useful to invest in an ISA before investing elsewhere.
This may be especially beneficial in the future as the Dividend Allowance and CGT Annual Exempt Amount will both halve on 6 April 2024 when the new tax year begins.
3. Lifetime ISA
The Lifetime ISA is designed to help savers buy their first home or build wealth for retirement.
You can open a Lifetime ISA if you are aged between 18 and 40. You can contribute up to £4,000 each year until you turn 50, and this counts towards your £20,000 ISA allowance.
You can hold investments, cash, or a mix of both in your Lifetime ISA and the government adds a 25% bonus to your savings, up to a maximum of £1,000 a year.
Typically, you can only withdraw funds from your Lifetime ISA if you are:
- Buying your first home
- Aged 60 or over
- Terminally ill with less than 12 months to live.
If you withdraw funds for any other reason, you will likely trigger a 25% tax charge. This essentially recovers the government bonus you receive on your savings.
As such, a Lifetime ISA may be useful for first-time buyers.
It could also be useful for saving for retirement but there may be more effective options, such as increasing your pension contributions, because you can only pay up to £4,000 into a Lifetime ISA each year.
4. Junior ISA
You can open a Junior ISA (JISA) for any child under the age of 16 and there are two types available – a Junior Cash ISA and a Junior Stocks and Shares ISA.
A JISA is an excellent way to start saving for a child or grandchild and give them a financial head start later in life. When they turn 16, they can start making contributions of their own and then make withdrawals when they are 18.
You have a separate JISA allowance of £9,000 in the 2023/24 tax year.
This is entirely separate from your own £20,000 ISA allowance. So, you can build savings for a child or grandchild while also contributing to your own ISAs.
Get in touch
If you want to explore the different types of ISA and how they might benefit you, we can offer some guidance.
Please get in touch to find out how our team of VouchedFor Top Rated planners could help today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.