ISA rules explained

Individual Savings Accounts (ISAs) are bigger and better than they’ve ever been thanks to generous investment allowances, greater flexibility and choice. Here’s your essential round-up of the ISA rules so you can make the most of your full allowance.

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:

  • How much you can invest in ISAs.
  • What tax benefits ISAs offer.
  • How you can pass on ISAs when you die.

You can put up to £20,000 into tax-efficient ISAs in the 2018-19 tax year.

Find out more about our Investment ISA

Use it, don't lose it

If you don’t make use of your annual ISA allowance, it’ll be gone for good once the next tax year starts. It can’t be carried over to the following year, so if you don’t use it, you’ll lose it.

How the allowance can be split

You can put your entire annual allowance into a cash, an investment, or an innovative finance ISA. Alternatively, you can split your allowance between these three types of ISA and the lifetime ISA. However, with a lifetime ISA you can only pay in up to £4,000 in each tax year.

You can also transfer money freely between cash, investment and innovative finance ISAs. If you’re transferring contributions made in the current tax year, then they must be transferred in full. But if contributions were made in previous tax years, you can choose what proportion of these you want to transfer. The ISA flexibility rules do not apply to the lifetime ISA.

Cash ISA and Innovative Finance ISA tax advantage

A cash ISA is simply a tax-efficient savings account. This means there’s no income tax to pay on the interest you earn, unlike other savings accounts where you must pay income tax on any interest you receive over your annual savings allowance (see below).

Similarly, with an innovative finance ISA there’s no income tax to pay on the interest you earn from peer-to-peer lending platforms.

Changes to tax on interest earned outside an ISA introduced on 6 April 2016 may influence the decision for many on whether to hold cash inside or outside of an ISA. Basic rate taxpayers now have an annual tax-free personal savings allowance of £1,000 and higher rate taxpayers a £500 allowance, which could see cash ISAs only being attractive for those with savings income in excess of these allowances.

Investment ISA tax advantages

The important thing to remember about investment ISAs is that, unlike cash, investments held can fall in value as well as rise, so you may get back less than you invest. Investment ISAs are tax-efficient where gains are concerned as there’s no capital gains tax (CGT) to pay. The 2018-19 CGT annual allowance for each UK resident individual is £11,700. Gains that don’t exceed this amount aren’t taxed regardless of whether they’re held inside or outside an investment ISA.

With investments held in an ISA, any interest or income you may earn from interest-bearing investments, such as cash, corporate bonds and gilts is not subject to tax. This income held outside an ISA is only taxed if it exceeds to the new annual tax-free personal savings allowance described above.

You also don’t pay tax on dividends from shares held in an ISA. If shares are held outside an ISA, all investors have a tax-free Dividend Allowance of £2,000, so if your dividend income is less than this there’ll be no tax to pay. Any dividends received above this amount are charged at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

When planning, you need to keep in mind that ISA and other tax rules may change in the future. They could be amended or abolished. Also, the benefits to you of any favourable tax treatment depend on your individual circumstances, which may change over time as well.

Lifetime ISA tax advantages

The lifetime ISA can hold either just cash or cash and investments, depending on which type ISA providers offer.1 It is intended to help savers get on the property ladder for the first time or contribute towards their retirement savings.

Similar to cash and innovative finance ISAs, there is no income tax to pay on any interest earned on cash in a lifetime ISA. And, also similar to an investment ISA, if you invest with your lifetime ISA, you won’t pay tax on dividends received or any capital gains tax (CGT) on the growth of your investments.

Additionally, the government pays a 25% bonus on all cash paid in, up to a maximum of £4,000. This is equivalent to £1 for every £4 saved, but if you withdraw money without respecting the lifetime ISA rules then you pay back the government bonus you have received and a 5% withdrawal charge will be applied to the amount you withdraw. Remember, tax rules can change and whether they are of any value to you depends on your individual circumstances.

You put your cash in, you take your cash out

ISA rules changed in the 2015 Budget. Since April 6 2016, if you save into an investment, cash, or innovative finance ISA, you can take money out of your account and put it back in within the same tax year without this affecting your annual allowance. Not all ISA providers may offer this flexibility, so check with yours before withdrawing any money. The ISA flexibility rules do not apply to the lifetime ISA. Remember too that investments are for the longer term - typically a minimum of five years. If you have to sell investments to take cash out of your ISA you are more likely to lose money.

Don’t exceed your allowance

Keep a close track of how much you pay into all of your ISAs to avoid exceeding your annual allowance.

If you accidentally put too much into your ISAs in any one tax year, and your ISA manager becomes aware of this, they should let you know that HMRC will contact you in due course.

Passing on ISAs when you die

You can pass on your ISAs to a surviving spouse or civil partner when you die and they should be able to retain the tax benefits. This is because ISA rules, which came into effect on April 6 2015, grant your surviving partner an extra allowance for their own ISA, known as an ‘additional permitted subscription’ (APS) allowance. The APS allowance is equivalent to the amount you hold in your ISAs when you die, and doesn’t affect your partner’s normal ISA allowance.

If you decide to leave your ISA assets to someone else, your spouse or civil partner will still be entitled to an APS allowance equivalent to the value of your ISA assets when you die.

So, for example, if you left £25,000 of ISA assets to your brother or sister, your partner would still benefit from an increased ISA allowance of £25,000 on top of their annual ISA allowance.

If you leave your ISA assets to your spouse they’ll be exempt from inheritance tax (IHT) but, if you leave them to other relatives or friends, the assets will form part of your estate potentially liable to IHT.

A time limit applies for your spouse to use their APS allowance, which is the later of three years from the date of death or 180 days after the administration of the estate is complete.

Remember though that tax rules can change in future and their effects on you will depend on your individual circumstances, which can also change over time.

Please bear in mind that this article is for general information purposes only. If you are unsure about how to invest your ISA allowance, seek professional independent advice.

Find out more about the APS allowance

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