What is an investment ISA?

What you’ll learn:

• How investment ISAs work
• How much you can invest
• How to open an investment ISA.

An investment ISA (Individual Savings Account) is a tax-efficient wrapper in which you can buy, hold and sell investments.

Usually when you invest you have to pay tax on any income or capital gains you earn from your investments. But with an ISA, you set up with an accredited and regulated ISA provider and, provided you stick to the rules on how much you can pay in, all capital gains and income made from your investments won’t be taxed.

Every tax year you have an ISA allowance, which is currently £20,000 for the 2023-24 tax year. Crucially, if you don’t use the allowance there’s no option to carry it into the next tax year. It’s a case of use it or lose it.

ISAs can also make your life easier. Any returns that you earn in your ISA don’t need to be recorded in your tax return because they’re tax free. So, you don’t need to keep track of the capital gains you make on these investments, and if all your savings and investments are in ISAs, it may mean that you don’t need to complete a tax return.

Find out more about ISA allowances

How investment ISAs work

Investment ISAs allow you to hold a far wider choice of investments than just stocks and shares. These include collective investment funds, Exchange Traded Funds (ETFs), investment trusts, gilts and bonds.

All of these are investments that can fall in value as well as rise, so you must accept the risk that you may get back less than you invest. And it’s never a good idea to invest purely for a tax benefit – you could lose more than the tax break is worth.

Rules on ISAs introduced by the government in 2014 also let you include investments that are generally viewed as less liquid (meaning they may take longer to sell) and are classified as higher risk. For example, shares listed on the small and medium-sized company exchanges Alternative Investment Market (AIM) and NEX Exchange. At the other end of the scale, the rules also let you include cash and cash-like investments in an investment ISA.

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

A tax-efficient account to use not lose

ISAs allow you to invest your ISA allowance every year without Capital Gains Tax (CGT) or income tax to pay on the returns.

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

This tax year you can put up to £20,000 into ISAs. You can split your allowance between a cash, investment, innovative finance and lifetime ISA and all gains will be free from income tax and Capital Gains Tax. With a lifetime ISA,¹ however, you can only pay in up to £4,000.

Capital gains

If you invest outside an ISA, any profits made above the annual CGT allowance, which for the 2023-24 tax year is £6,000, are subject to tax at 10% or 20% depending on your tax band. When you invest in an ISA, even if the profit you make is above this £6,000 threshold, you won’t have to pay CGT.

However, if you sell an ISA investment at a loss, you won’t be able to offset that loss against any gain you might make on the sale of other assets you hold outside of your ISA.

Income tax

There's no tax to pay on any income earned from interest-bearing investments such as corporate bonds, gilts and property income distributions from property funds when they’re held within an ISA.

Dividend income tax

The tax free dividend allowance for the 2023-24 tax year has been halved from £2,000 in 2022-23 to £1,000. It will fall further to £500 from April 2024. Any dividends received above the allowance are charged at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. However, when dividend income is received from investments held within an ISA, there’s no dividend income tax to pay for all investors.

Starting and managing your ISA

You can invest your ISA allowance entirely in either in a cash, investment or an innovative finance ISA, which invests in peer-to-peer lending.

Alternatively, you can split your allowance between these three types of ISAs and the lifetime ISA. With the lifetime ISA, however, you can only pay in a maximum of £4,000 in the current tax year. So if you’ve already put £5,000 into a cash ISA in the current tax year, you can add another £15,000 to it, or put it into an investment or innovative finance ISA, or put £4,000 into a lifetime ISA and spread the remaining £11,000 between the other three types of ISA.

You can open a new ISA with a different provider each tax year if you want to – there’s no rule that says you have to stay with the same provider year.

Transferring ISAs

If you already have an investment ISA, you can transfer it to a new provider if you want to. You can transfer money held in a cash ISA into an investment ISA, and vice versa.

Transferring ISAs from previous tax years won’t count towards your current year’s ISA allowance and you can choose to transfer all or part of the balance. But if you do transfer an ISA that you've contributed to in the current tax year, you must transfer all of it.

You’ll need to follow the correct ISA transfer process with your new provider to retain your ISA benefits. If you transfer cash from an existing ISA into a lifetime ISA it will count towards your lifetime ISA allowance for the year and qualify for the government bonus, but it won’t count towards your overall ISA allowance.

It’s also a good idea to check whether any ISA you're considering moving to is flexible or not. With flexible ISAs, if you want to take money out of your ISA and put it back later in the same tax year, you won’t lose any of your tax-free entitlement. Repayments must be made in the same tax year as the withdrawal.

There are various reasons why you might want to make an ISA transfer. For example, you might want to transfer to a provider offering a wider range of funds. Another reason could be the chance to reduce your overall investment costs. Always weigh up the pros and cons before transferring. If you have to sell your investments in order to make a transfer, you’ll be out of the market for a period of time. This could have an impact on your returns. If you’re unsure about any aspect of such a transfer, talk it over with a financial adviser first.

Record keeping

There’s no obligation to declare ISAs on your tax return, but it’s a good idea to keep note of what goes in and what comes out each year. This record-keeping will also help you stay within the annual ISA allowance. If you have our Investment ISA, your investments are all recorded on your ISA account page.