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Finding your flavour: which ISA is right for you?

Catherine Elliott10 May 2019

ISAs (Individual Savings Accounts) are probably the first port-of-call for many savers and investors.

One of the best-known tax ‘wrappers’, they allow you to carve out a section of your savings or investments from the taxman, so that all your interest or investment growth is earned tax-free.

And so regardless of your life stage and savings goal — whether it’s your first home or your retirement — it’s not hard to see why they’re the bread and butter of any savvy investor’s portfolio.

You can save or invest up to £20,000 across all of your ISA wrappers (combined) for the 2019/20 tax year. Although there’s no limit to how many ISAs you can have, you can only open — i.e. pay into — one of each type (more on those below) every year.

By ‘maxing out’ their ISA, many investors have managed to build up some sizeable nest eggs over the course of their lifetime. Some have even managed to become ‘ISA millionaires’ on the back of some extraordinary — and not to be relied upon! — market performance. So it’s generally wise to contribute as much as you can as early as you can.

But the once simple ISA landscape has become somewhat more complex over the last few years, with a few new flavours added to the mix in recent years. So here’s a quick guide to help you brush up.

The usual suspects

Any UK resident over 16 can open a cash ISA. They act like any usual savings account, and so offer different degrees of flexibility depending on your needs — instant access, fixed term, or regular saver. The only difference is that any interest you earn is tax-free.

Similarly, a stocks and shares or investment ISA acts just like any General Investment Account — you can choose whatever investments you like to hold within it — except that any capital gains from investment growth or any dividends or income you withdraw are beyond the taxman’s reach.

But remember, as with any type of investing, you should understand the risks involved before diving in. The value held in a stocks and shares ISA can go up or down.

Lifetime ISA

One of the newer ISA types, the Lifetime ISA (LISA), came onto the market in April 2017 and is geared towards long-term saving — specifically retirement or buying a house. It’s available to anyone aged between 18 and 40.

Each year, you can contribute up to £4,000 (of your total £20,000 allowance), and the government will top it up with another 25% of what you’ve put in (e.g. if you pay in £2,000 in one year you’ll have £2,500 in savings). A Lifetime ISA can either hold cash or stocks or shares.

You can make contributions each year until you’re 50 — after this, your savings will still earn interest but you’ll no longer benefit from the additional 25% bonus.

You can only access your LISA when you turn 60, or before that, if you’re using your funds to buy your first home. In any other case, you’ll be hit with a 25% charge on anything you’ve saved, including government contributions. So while the government bonus is very attractive, you need to be sure you can actually realise the benefits of your LISA in the future.

Innovative Finance ISA

Introduced at the same time as the Lifetime ISA, the Innovative Finance ISA (or ‘IFISA’ for short) allows you to invest through peer-to-peer lending platforms without paying tax on any interest you earn.

Peer-to-peer lending platforms work by matching those looking to borrow (for example smaller companies or property professionals), with those who have money to invest — cutting out the traditional middleman (the bank) and potentially offering both sides a better deal: lower rates or faster finance for borrowers, and the chance for investors to target attractive, inflation-beating (but by no means guaranteed) returns.

The market is hugely diverse, with a vast array of different interest rates on offer — typically dependent on the types of loans that you’re investing in. Perhaps the biggest difference is between loans that are secured against an asset that can be sold if the borrower fails to repay, and those that are unsecured (and so potentially higher risk).

With this type of ISA, there can be greater risks involved — the person you’re lending to may not pay up on time, or may fail to repay entirely — and your investments aren’t protected by the Financial Services Compensation Scheme. They’re only for sophisticated investors, and so it’s worth speaking to an adviser if you’re not sure whether it’s right for you.

Help to Buy ISA

For first time homeowners, this new(ish) ISA, introduced in 2015, could be a good way of getting a foot on the property ladder.

You can open a Help to Buy ISA with £1,000 but you’ll need a minimum of £1,600 before you can start earning the additional bonuses. A Help to Buy ISA also has to be held in cash, not stocks and shares.

Any cash you put in over £1,600 will be topped up by 25% from the government, up to a limit of £12,000. So for every £200 you save into a Help to Buy ISA (the monthly allowance), the government will add an extra £50, up until you’ve earned a maximum of £3,000 in bonuses.

These types of ISAs are only for first-time buyers — if you’ve ever bought any property elsewhere before (including overseas), you won’t be eligible.

You can use your ISA to buy a house worth up to £250,000 anywhere in the UK, or £450,000 if it’s London you’re going to call home.

Junior ISA

If you want to start saving for your little ones before they can do it themselves, Junior ISAs (JISAs) could be a good option.

They work in exactly the same way as regular ISAs, except with a lower allowance: the current JISA allowance for the 2019/20 tax year is £4,368. Remember, though, this is in addition to your own personal allowance of £20,000 per year.

As with the adult ISA, you can set up junior cash ISAs or junior stocks and shares ISAs. In both cases, the returns (be it interest, capital growth or dividends) will be tax free.

Only parents can open a junior ISA for their kids (a grandparent or other family member can’t), but once it’s set up others can pay into it. It’s worth noting that it’ll technically belong to your child: when they turn 18 they’ll have full access to the account and any funds in it — and free reign over what they do with it…! If you want a more restrictive way of saving for kids’ future, you’ll need to look elsewhere.

ISAs can be a great way to kick-starting your savings planning.

“Can’t I just keep everything in my normal savings or investment account?” you ask. Well, you can. But you’re not going to benefit from the same tax relief if you do — and you’ll potentially be throwing away money in tax.

And when you’re building a savings or investment portfolio over many years, that amount can really add up. The longer you contribute to your ISA, the greater your total pot will be; and, consequently, the greater your year-on-year returns will be, too, thanks to that wonderful thing called ‘compound interest’.

If you’re interested in setting up a new ISA, or aren’t sure if you’re making the most out of your existing ISAs, a financial planner can help. They’ll help you choose the right options for you and make sure you’re using all the allowances available to you. Get in touch today to find out more.

As with any type of investing your funds could go down as well as up, so it’s important to choose the right ISA that matches your saving needs and your risk appetite.

It’s also important to ensure you aren’t subscribing to too many ISAs in the same tax year or exceeding any limits. Your own tax treatment will depend on your personal circumstances — and remember that tax rules change regularly.

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