Five ISA myths exposed

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.

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.

What you’ll learn:

  • What the main types of equity and bond funds are.
  • What the difference is between active and passive investing.
  • What multi-asset and multi-manager funds are.

This tax year (2018-19), 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 2019, 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 new Innovative Finance ISA. Alternatively, you can use a combination of these, so you can contribute to one cash ISA, one investment ISA and one innovative finance 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 ISA

New 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%.

The reduction of the Dividend Allowance means that any dividend income above £2,000 is subject to tax from this date. This means that tax-efficient wrappers such as ISAs will become more important for investors seeking to reduce their increased tax exposure.

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 2018-19 tax-year is £11,700. The standard CGT rate is 10%, while the higher rate is 20%.

Remember that tax rules can and do change, and their effect on you depends on your individual circumstances, which can also change over time.

Bear in mind too 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.

In the case of cash ISAs, remember that the higher interest rates go and the more interest you can earn on deposit accounts, the less beneficial the PSA becomes. Meanwhile, the tax-free status of your existing ISA savings becomes even more beneficial, as the increased 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

ISAs have become much more flexible since April 2016. Previously, if you deposited your entire allowance into an ISA but then withdrew some of it, whatever you took out would lose its tax-free status.

Now, 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 2018/19 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 or fund, you can switch at any time without it affecting you ISAs 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. And you can choose to transfer just part of your savings held in ISAs if you want to, unless you’re transferring money you’ve invested in an ISA this tax year, in which case you must transfer all of it.

However, 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 are transferring cash after selling your investments which you 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. The value of investments can fall as well as rise, and you may get back less than you invest.

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.

You may also be interested in

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.

Before transferring, read about the disadvantages, risks, charges, penalties, benefits you'd lose or investments you can’t transfer to us.

Transferring ISAs

There are a number of reasons why transferring your Individual Savings Account (ISA) could stand you and your investments in good stead.

ISAs are more flexible than ever

Saving into a tax-efficient ISA is even more appealing now some providers are offering greater flexibility on these accounts. We explain how flexible ISA rules work, and how they could benefit you.

Investment ISAs

Investment ISA

Try a sweeter way to invest and use your 2018/19 ISA allowance of £20,000. You won’t get taxed on any money your ISA makes.