With the tax year end in sight, it’s important to make sure you’re making the most of your tax-free allowances, ISAs can be a great way to do that. You can put up to £20,000 away into ISAs and any returns you make on money within them is free, an attractive prospect for those who wish to save or invest.
How do ISAs work?
If you’re unsure of the benefits of ISAs or you don’t make the most of yours as you simply aren’t sure how they work then this article will be a beneficial 10 minute read for you! We dispel five common ISA myths so they don’t prevent you from making the most of this year’s £20,000 allowance before the tax year is up. Remember, if you don’t use it, you lose it.
Myth One – I can only have one ISA
There are four different types of ISAs: ‘Cash’, ‘Investment’(also called stocks & shares ISAs), ‘Lifetime’ and ‘Innovative Finance’. Cash ISAs are the simplest and most popular type of ISA on the market.
You are able to split your allowance between more than one type of ISA, you cannot however pay money into more than one of the same type of ISA in the same tax year. For instance, if you have already put some of your allowance into a Cash ISA, you cannot then open another Cash ISA with a different provider and pay into that too – any additional money would have to go into the ISA you’ve paid into or another type of ISA you may have such as an Investment ISA.
If you want to open another ISA with a different provider, you can do this when the new tax year starts on 6th April.
Myth Two - I'll have to declare ISAs on my tax return
Quite simply, you don't. That's the point of an ISA, they’re tax free. ISA income does not count towards the personal savings allowance or dividend allowance.
It is worth noting ISA rules may change in the future, and that the value of any favourable tax treatment to you will depend on your individual circumstances.
Myth Three – The Dividend and Personal Savings Allowances mean ISAs aren’t worth bothering with
There are other tax allowances which mean you may not have to pay tax on savings and investments that are held outside of an ISA, which can lead people to believe that ISAs may not be worth setting up. For example, you can receive up to £2,000 a year tax-free from dividends which may be enough for some but if you build up an investment portfolio you may find over time that you exceed the annual allowance in dividends. You will then need to pay tax on this, with ISAs you won’t.
Similarly, gains on investments are liable to capital gains tax (CGT). You could stagger the sale of your investments over a number of years to avoid CGT but with an ISA, you don’t have to worry about the amount of profit you may have made when you want to sell as CGT won’t be applicable.
Myth Four - ISAs are risky
Cash ISAs are just as safe as ordinary savings accounts. But there will be an element of risk when you invest in stocks & shares. And, ISAs are just a wrapper around the investments you have chosen. It's no more or less risky than investing in the same assets outside an ISA.
Myth Five – You can’t take money out and pay it back in
You should be able to withdraw money from your ISA and pay it back in within the same tax year without it affecting your annual tax-free allowance. There are always some providers who do not offer this so it is worth checking with yours before taking out any money from your ISA.
Myth Six – You have to decide which investments you want to hold in an Investment ISA before you open it
If you want to make the most of this year’s allowance by investing in an ISA but you have yet to decide where to put your money, you can simply pay it into the ISA but keep it as cash until you’ve made up your mind. This is also a useful alternative if you’re not ready to invest or are unsure of the market conditions.
When you are ready to start investing it might be attractive to set up small regular automatic investments, however it’s worth considering the impact fees will have on your investment. It’s worth figuring out whether the minimum monthly fee could make it expensive and therefore exceed the returns you hope to gain.
Myth Seven – Once you’ve chosen an ISA, you can’t change it
In recent years ISAs have become more flexible. It is possible to switch from Cash to Investment ISAs and back again conversely. Just check with your provider they accept transfers and there are no penalty charges for doing so.
As much as you can transfer money you put into your ISA in the previous tax year, if it is money you have paid into your investment ISA during the current year you’ll have to transfer the full amount.
Considering transferring money from a Cash ISA to an investment? Make sure you understand the risks associated with this and that you are comfortable with them. The potential high returns of investing overtime can be attractive but their value can also fall and you could get backless than you originally invested. So, take your time and do your research before jumping in.
Please bear in mind that this article is for general information purposes only. Before saving or investing it is advisable to seek professional financial advice.
Would you like further advice? Give us a call and we can talk you through how you can move forwards with investments and build a solid portfolio.
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Looking for other ways to save? Check out our article ‘Personal tax planning: 7 ways to save’