A Guide To Understanding ISAs

We should always be keeping our gains from Her Majesty’s Revenue & Customs (legally, of course) where possible as none of us wish to pay any tax we are not obliged to do so.

Luckily for us, the UK government is very generous with offering all who have a National Insurance number the option to save cash in an Individual Savings Account (ISA) which is a tax-free account.

Individual Savings Accounts (ISAs)

As private investors in the UK, we benefit from the advantage of ISA accounts. Those with a National Insurance number have a £20,000 allowance to be used annually.

These accounts come in two forms: cash ISAs, and Stocks & Shares ISAs. We are able to put money into both of these accounts every tax year, up to the sum of £20,000 per annum between the two. Given the low rates of interest, cash ISAs are unappealing to me, as I can generate much higher returns in the equity markets – but that does not mean cash ISAs are no good. It is entirely dependent on your own situation.

Remember, we cannot carry our balance over from one year to the next, so the golden rule for ISAs is ‘use it or lose it’!

There are some key points to remember regarding ISAs before we look into each of them in more detail:

  • Each person has an annual limit of £20,000 every tax year
  • ISAs act as tax-free wrappers
  • Stocks & Shares ISAs are great for holding investments because any profits are exempt from Capital Gains Tax

Whilst one argument is that one cannot write off tax losses in an ISA account, I believe this is silly because that surely nobody is aiming to make any tax losses.

The Two Stock Investing ISAs

There are two forms of ISAs that are available for stock investing. There is the Stocks & Shares ISA, and there is the Lifetime ISA.

We are able to split our cash and pay into both a Stocks & Shares ISA as well as as the Lifetime ISA – so long as we don’t breach the annual ISA limit of £20,000.

Stocks & Shares ISA

The Stocks & Shares ISA is offered with many providers (check the fees first) of which some offer a ‘flexi-ISA’ – meaning we are able to take money out and replace this within the same tax year. To open a Stocks & Shares ISA is very simple – log on to your online broker and there will be an option to do so. Only a National Insurance number is required.

The Lifetime ISA (LISA)

The Lifetime ISA was launched in April 2017 and not initially a roaring success. As the government wishes to convince more people to save in an attempt to quell the inevitable pension crisis, savers can contribute up to £4,000 with the government adding a bonus 25%.

The makes the maximum amount of free cash per annum £1,000. Another who is over 18 and below 40 can open a LISA. The government bonus is from the age of 18 to 50, meaning that the maximum amount of free cash you can receive from the government is a whopping £33,000.

Unlike the Stocks & Shares ISA, for the Lifetime ISA there are limitations on withdrawal. The Lifetime ISA was designed to be used for savers to create a nest egg independently; however, one can cash this out when buying a home for less than £450,000, or when they turn 60. This means that if you contribute the maximum amount per year for five years before buying a house, then the government will have given you £5,000 in free money to use against the purchase of your first home.

Depending on the provider, it is possible use the cash inside the Lifetime ISA against the purchase of your first home and then keep the account open to take advantage of the benefits and cash out the account at 60. It is worth checking carefully as this tax-free account brings plenty of free upside.

Risk-free Upside Within The LISA

Another advantage of the LISA is that it offers stock market upside without having to lose any of the principal invested into the LISA. With a £4,000 deposit up to £1,000 of that could be used to invest leaving £3,000 in cash. This would mean that 100% of the invested capital could be lost with no real risk to the principal deposited as the government will top up your account with £1,000 at the end of year, with the account after bonus closing at £4,000. This amount of risk free upside can be adjusted accordingly to one’s risk profile, and investing less than 25% of the deposit would guarantee LISA growth whilst having exposure to the stock market. However, investments can go down as well as up and it is encouraged to understand the risk profile of the financial instruments before purchasing. If you are married, then your partner can also open a LISA and you can get double the amount for free.

Junior Individual Savings Accounts (JISAs)

A Junior Individual Savings Account can be used as a tax-efficient way to save or invest for your child. Currently, contributions of up to £4,260 can be made per tax year.

JISAs need to be opened by either a parent or a legal guardian, but others are able to contribute to the account such as extended members of the family and even friends.

However, once the child reaches the age of 18 the money then becomes theirs to control. That means that those years of prudent investing can be blown in just a few months on a trip to Magaluf and a brand new car to impress their peers, which depreciates faster than the money can be replenished. If you wish to retain control over the money for longer, a JISA is not the best option.

Be Wary Of Stock Market Movements

If the JISA is to be put towards a special event such as university funds or a house deposit, it makes sense to be careful of having the account in equities. Nobody knows when the stock market can see a downturn, and if the account loses value sharply a year before the liquidity event is required then this would be disappointing for all involved. Stocks can go down as well as up! Cash is a position, and can be held in the JISA.

Disclaimer

I am not a financial adviser, and this post is not investment advice. I trade and invest my own capital on a full time basis in the stock market but all posts on this website represent my opinion and interpretation of the facts and it is possible there may be errors. Please consult a regulated financial adviser should you wish to speak to someone about your situation.

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