ISAs are a much misunderstood beast. Many in the industry try to sell them to the consumer as a product whereas the legislation means for them to be used as an allowance to wrap around eligible investments to protect them from tax, so boosting a savings plan.
With the introduction of several new 'flavours', it is worth a reminder of what the ISA is, where it fits in an individual savings plan and what types are available.
Each of us in the UK has an annual ISA allowance, currently £15,240 but rising to £20,000 from April 2017. We can hold cash, shares, bonds and other eligible investments inside the ISA 'wrapper' which can then grow, protected from income and capital gains tax.
There are currently 6 main types of ISA, with another due to join the family from April 2017:
- Cash ISA - where cash can be held up to the ISA limit
- Stocks and Shares ISA - where eligible stocks and shares can be held up to the ISA limit
- Junior ISA - an ISA that adults can set up for minors up to the current ISA limit of £4,080
- Help to Buy ISA - an ISA for first time house buyers, subject to defined savings and usage rules but with a 25% government bonus
- Innovative Finance ISA - allows you to use your ISA savings with peer-to-peer lenders or to invest in companies through crowdfunding. This is higher risk and is not covered by the Financial Services Compensation Scheme if the borrowers default
- Inheritance ISA - new since December 2014, this allows a widow/ widower/ civil partner to open an ISA for the unused balance of their partner's ISA allowance in the year of their death
- The Lifetime ISA or LISA, as it is becoming known, will be added to the ISA range from April 2017. The intention is that it can be used to help fund a house purchase (similar to the Help to Buy ISA) and/or be used to save towards retirement. It is subject to specific savings and usage conditions and also has a 25% government bonus
ISAs are a useful part of a financial plan; they allow a tax-free environment to shelter certain investments. When looked at in this way, a couple each with an annual ISA allowance of £20,000 (from 2017) would be able to shelter total savings of up to £200,000 over a 4-year period such that those investments can earn dividends and increase in value in the future with no liability to income or capital gains tax.
Financial planners will make use of this valuable tool to ensure clients' investment portfolios are building in the most tax-efficient way and will look to use their client's ISA allowances each and every year.
Investing in line with your objectives, circumstances and attitude to risk and then making your investments tax-efficient by using the ISA to wrap around those investments to protect them from future tax is the recommended route for effective financial planning. Buying an ISA off the shelf with a random selection of investments already inside it is not.
The ISA allowance is a great benefit for savers but choosing which type or types are most suitable and then ensuring you use the allowance to protect your investments, rather than seeing it as an investment itself needs careful consideration, selection, guidance and advice.
An Individual Savings Account, or Isa, is a tax-free home for your savings. It's a type of account that works like a wrapper. You can put a range of different investments inside it: they all then benefit from tax-free growth. The right Isa for you depends on your age, savings goals and attitude to risk.