With the tax year coming to a close, it’s a good time to check if you’ve made the most of your ISA allowance and what type of ISA you should consider for the next tax year. We’ve highlighted some key info below to help you pick the right ISA option for you.
ISAs, other than being another indecipherable financial acronym, are Individual Savings Accounts, a type of savings or investment account in which you don't pay any taxes. In the UK, you have a yearly ISA allowance which is up to 20k for the 2019/2020 tax year. An ISA is a must-have if you're just getting started with investing.
There are four main types of ISAs - Cash ISA, Stocks and Shares ISAs, Innovative Finances ISAs and Lifetime ISAs. It can feel like four too many but we’ve broken it down so you can decide what makes sense for you.
A Cash ISA is like a bank savings account that you never have to pay tax on. You earn a small amount of interest and your account value never goes down. There are two types of cash ISA - flexible and fixed. The flexible option allows you to withdraw and deposit cash as often as you need to. The fixed option locks in your cash for a fixed time period and interest rate.
What you should consider - If you are in the 40% taxpayer rate (this is based on your income) it means you would have to pay tax on any interest you earn over £500, so a cash ISA is good to consider. You would be in this bracket if you have 100k in a savings rate with 0.5% rate so it’s totally fine if you're not there yet! Otherwise Cash ISAs are a very safe option, the only downside is that interest rates are abysmal right now so your return is going to be quite small.
You can invest your allowance in a stocks and shares ISA and not pay capital gains or tax on any income generated from your investments. This ISA, despite its name is not just limited to stocks and shares and you can also use it to buy investment funds such as ETFs, trusts or bonds.
What you should consider - This type of ISA is more risky but can give you better returns than Cash ISAs. If you have some money already saved in an emergency fund and have some cash to spare, it would be good to consider this option. Most online brokers offer ISAs but make sure to shop around and consider the fees involved.
An innovative finance ISA allows you to use your tax-free allowance while investing in peer to peer (P2P) lending. P2P lending is like financial matchmaking and matches up people who want to lend money and get good returns, with people & businesses who need to borrow money. The borrowers then pay back the borrowed money with interest on top, which is interest you earn tax-free in your ISA account.
What you should consider - You can get up to a 6% interest on the money you lend but this is not like a savings account as your capital is still at risk and you should treat P2P lending as making more of an investment. You are only allowed to put 10% of your investable assets and should only make an investment if you have an emergency fund set up with some cash to spare. Additionally due to the pandemic, investors have had difficulty in getting their money back. However you can lower your risk by choosing options with a lower interest rate and still get better returns than a savings account.
This ISA works a bit differently, where it’s not tied to an allowance and you can get a lifetime ISA on top of a Cash/Stock or P2P ISA. It lets you save up to £4000 towards your first home or retirement and then the government gives you a cash bonus of up to £1,000 a year on top.
What you should consider - You can only use this cash towards your house purchase or retirement. Your house purchase value must be lower than £450,000 (which may not be practical for London but great if you want to escape the city) for your lifetime ISA to be applicable. If it goes towards your retirement be prepared to only access that money when you hit 60. Currently you can withdraw your cash from your Lifetime ISA penalty free and use it on a purchase as long as it’s not for retirement or a house. Keep in mind though that penalties for withdrawal will be back in April 2021.
You can have all the different types of ISA’s as long as you don’t exceed the allowance for £20,000 a year. This does not apply to a Lifetime ISA which you can have in addition to your allowance.
It really depends on the type of ISA you have. Flexible Cash ISA’s are the best option if you need to take the cash in and out easily. It is also possible to sell your stocks and shares to withdraw funds. For your innovative finance ISA you can withdraw any uninvested funds or any interest payments you have received, but it will be difficult to access your full fund after you’ve loaned the money. Lifetime ISA’s currently have penalty free withdrawals, but this will be back in April 2021 with a 25% penalty on the withdrawn funds.
So why ISA? If you weren’t hooked in by the tax free earnings benefit, think of it as one of the simplest ways you can earn money on your current savings instead of just letting your cash sit in your bank account. Overall, our take is that Cash and Stock & Share ISAs are both solid options to try depending on how much risk you feel comfortable taking on.
We’ll also be following up with another post on different options you can try -so if you are considering an ISA sign up to our newsletter below and keep an eye out for our next post!
Illustration by Lina Leusenko
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