Individual Savings Accounts (ISAs)
In some ways, ISAs can be compared to pension plans, because the ISA is just a 'wrapper' around the investments that it contains (just like Personal Pensions that confers special tax privileges that would not be given if the investment funds were bought outside the Pension plan).
Individual savings accounts (ISAs) were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax exempt special savings accounts (TESSAs).
ISAs can consist of up to two investment components:
- The stocks and shares component. This can include virtually all quoted securities, as well as unit trusts, shares in open-ended investment companies (OEICs) and investment trusts. The quoted securities allowed include equities listed on any Recognised Stock Exchange. You can also invest in corporate bonds, as well as government securities issued by a European Economic Area government.
- The cash component. This can be invested in bank or building society deposits and certain money market unit trusts.
Previously, funds could be moved from a cash ISA into a stocks and shares ISA, but not the other way round. However, from 1 July 2014, the distinction between cash and stocks and shares ISAs was removed. This is known as a 'New ISA' (NISA).
This means that funds can move between cash and stocks and shares at will, and the rule that only half the allowance can be invested in cash has also been abolished.
Also, the under the old rules, any money taken out of an ISA lost its tax-free status. However, money can now be withdrawn and replaced without losing the tax-free status, as long as the repayment is done in the same tax year.
Historically there were two main types of individual savings account - a Mini and a Maxi ISA - but from 06 April 2008 this distinction was abolished, and there is just an 'ISA'. The annual ISA investment allowance has been raised to £20,000 as of 06/04/2019, and the entire amount can be invested in either cash, stocks and shares, or a combination of both. ISA savers will be able to invest in two separate ISAs each tax year - a cash ISA and a stocks and shares ISA.
Under the previous rules, if you put £1 into a mini-Cash ISA, you could only invest half of the annual ISA allowance into a mini-Stocks and Shares ISA. The new rules bring a little more flexibility, as you can now invest, say, £9,000 into the Stocks and Shares Component and £11,000 into the Cash Component or the entire allowance into either component.
Mini cash ISAs, Tessa-only ISAs (TOISAs) and the cash component of a maxi ISA were automatically treated as cash ISAs. ISA savers will be able to transfer money saved in their cash compent to their stocks and shares component.
Once you have chosen your Stocks and Shares or Cash ISAs, you may not invest in any other ISA during the tax year.
From April 2015, a new "Help to Buy" Isa scheme will help first-time buyers get onto the property ladder. For every £200 a first-time buyer saves, the Government will add a bonus of £50, effectively a 25% tax-relief. This bonus will be available for up to £15,000 only. Savers will have access to this money and will be able to withdraw funds from the Isa account if they need them for another purpose, but the bonus will be lost if not used for property purchase. The Help to Buy Isa will only be available on houses worth £250,000 or less, or £450,000 or less in London.
Note: Life insurance funds
Since April 2005 life insurance funds have qualified for stocks and shares ISAs. Previously there was a separate Mini 'life insurance' ISA component in which a maximum of £1,000 could be invested. This caused some confusion at the time, as many people suspected that an insurance-based ISA would naturally provide life insurance cover. What was actually offered was funds provided by Insurance Companies, such as With-Profits funds.
Existing Insurance ISAs can remain in force, but will now be amalgamated within the Stocks and Shares ISA component, though some might qualify for Cash ISA status. Anybody who previously subscribed to an insurance ISA and another ISA of the same component is no longer allowed to contribute to both. ISA rules do not permit investment in two ISAs with different managers if they fall into the same component (although this is rapidly becoming an obscure historical footnote).
Individual savings accounts have several major tax advantages:
- Freedom from capital gains tax.
- Freedom from income tax on interest from corporate bonds and dividends from foreign securities.
- Freedom from income tax on interest earned in the cash component.
It is worth noting that Stocks and Shares ISAs are not entirely 'tax-free', due to the fact that the Government abolished the ability of fund managers to reclaim the tax credit on UK dividend income in 2004. Therefore, there is some merit in holding Corporate Bonds and Gilts within an ISA, as the full 20% tax credit is still reclaimable.
You are free to draw from your plan at any time without adverse tax consequences.
NOTE: This document is intended to provide a brief overview of the subject. It should not be read as a recommendation to use any particular product, as it does not take into account individual circumstances and attitudes.