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Five ISA myths exposed

4 minute read

Many people don’t make the most of their annual ISA allowance because they aren’t sure exactly how ISAs work, or because they don’t think the benefits are really worth it. Here, we dispel five of the most common ISA myths that might be preventing you from making the most of this year’s £20,000 allowance before the end of the tax year on 5 April 2020.

Who's it for? All investors

The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.

What you’ll learn:

  • Why changes to the dividend allowance might make ISAs more important.
  • How ISAs are more flexible.
  • How you can hold cash in your Investment ISA until you decide where to invest.

This tax year (2019-20), you can put up to £20,000 into tax-efficient ISAs. If you don’t use this year’s allowance by the end of the tax year on 5 April 2020, it’ll be gone for good once the new tax year starts on 6 April.

If you’re not sure about key ISA features and whether they could benefit you, we’ve debunked some of the main ISA myths which often cause confusion.

Bear in mind that the tax rules governing ISAs may change in future, and that the value of any favourable tax treatment to you will depend on your individual circumstances, which can also change.

You can only have one ISA each tax year

You can pay your full ISA allowance into either investments, or cash, or peer-to-peer lending through the Innovative Finance ISA. Alternatively, you can use a combination of these, so you can contribute to one cash ISA, one investment ISA, one innovative finance ISA and one Lifetime ISA each tax year. You can move your ISAs between cash, investments and innovative finance ISAs if you wish in the future, and you can also hold cash in an investment ISA.

Find out more about our investment (Stocks and Shares) ISA

The Dividend and Personal Savings Allowances mean ISAs aren’t worth bothering with

On 6 April 2018, the amount of dividends investors can receive tax-free fell from £5,000 to £2,000. Basic-rate taxpayers must pay 7.5% on dividend income beyond the £2,000 annual allowance, higher-rate taxpayers pay 32.5% and additional-rate taxpayers pay 38.1%.

If you’re building up an investment portfolio over many years, you could find that your portfolio ends up generating more than the Dividend Allowance each year, although of course it may not. ISAs therefore remain important because if the rules don’t change they will protect assets from tax over the long-term, enabling them to grow free of income tax, tax on dividends and Capital Gains Tax (CGT).

If your investments aren't held in a tax-efficient wrapper, you'll be taxed on profits above the annual CGT allowance, which in the 2019-20 tax-year is £12,000. The standard CGT rate is 10%, while the higher rate is 20%.

Bear in mind that the value of your investments can go down as well as up, so you could get back less than you put in.

The Personal Savings Allowance (PSA), meanwhile, allows basic rate taxpayers to earn up to £1,000 in interest each year tax-free, and higher rate taxpayers up to £500. Additional rate taxpayers do not have a Personal Savings Allowance.

However, if you earn over this limit in interest on your savings – for example, if interest rates on your accounts increase – the tax-free status of cash ISAs becomes more important. Returns paid out on cash ISA accounts remains entirely tax free – assuming the potential tax breaks offered by ISAs are not withdrawn in future.

You can’t take money out and pay it back in

If you hold cash in either an investment, cash, or innovative finance ISA, you can take this out of your account and put it back in within the same tax year without this affecting your annual allowance.

So, for example, if you use £10,000 of your ISA allowance in the 2019-20 tax year, and take out £2,000, you can replace this £2,000 in the same tax year and you will still be able to pay a further £10,000 taking you up to your £20,000 allowance. Not all ISA providers offer this flexibility though, so check with yours before withdrawing any money.

You must decide which funds or investments you want to hold in an Investment ISA before you can open one

If you want to invest this year’s £20,000 allowance in an Investment ISA, but haven’t yet decided where to put your money, you can hold cash in your Investment ISA until you’ve made up your mind. The ability to hold cash in your Investment ISA can also be useful if you’re uncertain of market conditions and don’t want to invest immediately.

Once you’ve chosen an ISA, you’re stuck with it

If your ISA savings or investments aren’t performing as well as you’d hoped, or you want to move to a different provider, you can switch your investments or even provider at any time without it affecting your ISA’s tax-efficient status. You can also transfer from a cash ISA to a stocks and shares ISA or innovative finance ISA or vice versa if you want to. You can choose to transfer all or just part of your savings held in ISAs from previous tax years. However, if you are transferring savings paid into an ISA during the current tax year, you must transfer the full amount.

Before transferring your ISA, check whether you’ll have to pay any charges or exit penalties to move, or whether you may lose any benefits.

Find out more about the risks and drawbacks of transferring your investments

Remember too that if you’re transferring cash after selling your investments, which you then plan to use to repurchase them, you’ll be ‘out of the market’ for a time and will therefore miss out on any rise in value and on any income or other benefits from these investments during that period.

If you are transferring from a cash to an investment ISA or an innovative finance ISA, make sure you are comfortable with the higher risks that come with investing and lending.

If you want to transfer contributions made in previous tax years, you can choose what proportion of these you want to transfer. If, however, you are transferring contributions made in the current tax year, then they must be transferred in full.

Please bear in mind that this article is for general information purposes only. If you’re unsure, seek professional financial advice.

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The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice. Tax rules can change in future. Their effects on you will depend on your individual circumstances.

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