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Last updated: 22 Apr 2022
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Why consider investing in an Individual Savings Account (ISA)?

ISAs provide a good tax-efficient opportunity to put away cash or other investments to accumulate for the long-term. In this article, we’ve highlighted what you need to know about investing in ISAs for both you and your children, and the benefits that come with it.

What is an Individual Savings Account (ISA)?

An ISA is a fund which you can contribute to at your discretion, within a tax-free wrapper. This means that income and gains produced from investments within the ISA are essentially tax-free. 

Investments can be made either as large lump sums or smaller, more regular amounts. Every tax year, you can save up to the annual allowance (£20,000 in 2022/23) in a single ISA, or spread across multiple ISA accounts. 

The ISA can contain stocks and shares, cash or a combination of both. There are also opportunities to include peer-to-peer loans and crowd funding debentures within an innovative finance ISA.

You must either be resident in the UK, or a Crown servant or their spouse/civil partner if you do not live in the UK, to be able to open an ISA.

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Akin Coker

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cokera@buzzacott.co.uk

What is an Individual Savings Account (ISA)?

An ISA is a fund which you can contribute to at your discretion, within a tax-free wrapper. This means that income and gains produced from investments within the ISA are essentially tax-free. 

Investments can be made either as large lump sums or smaller, more regular amounts. Every tax year, you can save up to the annual allowance (£20,000 in 2022/23) in a single ISA, or spread across multiple ISA accounts. 

The ISA can contain stocks and shares, cash or a combination of both. There are also opportunities to include peer-to-peer loans and crowd funding debentures within an innovative finance ISA.

You must either be resident in the UK, or a Crown servant or their spouse/civil partner if you do not live in the UK, to be able to open an ISA.

What are the tax advantages of ISAs?

What are the tax advantages of ISAs?

Choosing to invest outside of an ISA could be very costly, particularly if you are a long-term saver. The table below shows the rate at which income and capital gains are taxed above your individual allowance, on investments outside of an ISA. Comparing those rates to the 0% tax on ISAs, demonstrates the potential savings.

Tax Rates 2022/23

 

Interest

Dividends

Capital Gains

Allowances/Exemptions

£1,000 BR/ £500 HR

£2,000

£12,300

Basic Rate (BR)

20%

8.75%

10%

Higher Rate (HR)

40%

33.75%

20%

Additional Rate

45%

39.35%

20%

Sustained investment in an ISA can see capital accumulate, the more so with the reinvestment of the tax-free dividends and interest. As the capital accumulates, you’ll see more of the tax-saving benefit over time.

Lifetime ISA

Lifetime ISA

The Lifetime ISA is a special type of ISA in that it is flexible in terms of the mixture of cash, stocks and shares it can contain, and is used for saving for the purchase of a first home or for later in life, such as your retirement. You must be between the ages of 18 and 40 to open one, while the maximum contributions you can make per year is £4,000 until the age of 50, after which you can no longer pay in. Any payments into a Lifetime ISA also count towards your £20,000 annual limit. The government will add a 25% bonus to contributions up to a maximum of £1,000 per year.

There are three circumstances in which money can be withdrawn from a lifetime ISA, which are if you’re:

  • aged over 60;
  • buying your first home; or
  • terminally ill, with less than 12 months to live.

In any other case, a 25% charge will be due when withdrawing funds in order to recover the government bonus. This makes the Lifetime ISA an ineffective way to save short-term.

Junior ISAs

Junior ISAs 

Junior ISAs (JISA) come in two types - a cash JISA or a stocks and shares JISA – and children can have one or both types.

Children are eligible for a JISA if they are under 18 and living in the UK, although there are exceptions for children of Crown servants living outside the UK. If you’re a parent or guardian with parental responsibility, you can open a JISA and manage the account, but the money belongs to the child, who then can take control of the account when they reach 16. They cannot withdraw the money until they turn 18.

While anyone can pay into the JISA, contributions are limited to a cap (£9,000 in 2022/23) which can be split between two ISAs. Once paid in, money can be transferred between JISAs and a Child Trust Fund account freely, but not into an adult ISA. JISAs automatically turn into an adult ISA when the child turns 18 and remain exempt from tax.

Gifts to children ordinarily cause complications because of the parental settlement rule. If the gift generates gross income above £100, be it interest or dividends, all the income is taxed on the parent who made the gift. Gifting into a JISA circumvents this risk, meaning parents do not suffer a tax liability from income generated by assets in their children’s name.

Can you move an existing portfolio into an ISA?

Can you move an existing portfolio into an ISA?

Stocks and shares ISAs only allow the introduction of cash, not existing holdings of shares, but there is the alternative strategy, known as bed and ISA, which entails the disposal of a portfolio before transferring the cash into the ISA and then using the cash to repurchase the shares. This will most likely realise a capital gain but given the annual allowance for ISAs is only £20,000, most gains will be under an individual’s annual exemption (£12,300 for 2022/23), assuming you have no other gains. If you routinely realise significant capital gains in your personal capacity, the tax can be considerable, but there is scope to coordinate the realisation of gains with utilisation of the annual exemption.

Taxation of ISAs on death

Taxation of ISAs on death

While gains and income produced within ISAs are not subject to tax, the value of an ISA still forms part of a deceased individual’s estate and is potentially subject to Inheritance Tax (IHT) at 40%. You can mitigate this cost by transferring their ISA to your spouse or civil partner on death, which is covered by the IHT inter-spouse exemption. 

The surviving spouse then has a choice.  The first option is to transfer the ISA into their own name, which must be done within 180 days of the beneficial interest being transferred by the executors. Alternatively, they can elect to take an additional ISA allowance equivalent to the value of the deceased partner's ISA when they died, even if those ISA funds are bequeathed to someone else in the will. This election has to take place within 180 days of the administration of their spouse’s estate being completed or by the end of three years after their death, whichever later. 

ISAs retains their tax-free status for up to three years from the date of death, so income and gains realised in the administration period of the estate will be exempt for the Executors.

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