Although individual savings accounts (ISAs) were first launched in the UK way back in 1999, it is somewhat surprising just how many people are still unaware of what they are and how they work. In its most basic form, an ISA allows you to avoid tax on your savings – up to a certain amount each year.
In the current financial year of 2019/20, this stands at a whopping £20,000. In other words, you have the capacity to save or invest £20,000 without paying single pence in taxation. On the contrary, traditional savings accounts that bear interest will be accustomed to annual taxation.
Furthermore, if you’re an avid stock market investor, capital gains taxes on your profits are even more costly. With that being said, you can also utilize your annual ISA allowance to shield investment gains from the tax-man.
Interested to find out more about how an ISA can help save you money? If so, be sure to read on!
How does an ISA actually work?
While the main concept of an ISA remains constant – insofar that they allow UK investors to avoid a certain amount of tax each year, there is now a range of different account types to choose from. Here’s a quick breakdown of what’s currently in the market.
- Cash ISA: A Cash ISA operates much in the same way as a conventional savings account. Depending on the specific Cash ISA that you opt for, you will be paid a variable or fixed rate of interest, and some accounts have restrictions on the number of withdrawals you can make.
- Stocks and Shares ISA: A Stocks and Shares ISA operates like a virtual shopping basket that allows your investments to avoid capital gains tax. You won’t be paid any interest from the respective bank, building society or broker, so your gains are dictated by how well your chosen investments perform. Typically stocks and shares ISAs outperform regular ISAs, however this is offset by the greater risk in investments.
- Help to Buy ISA: If you’re looking to buy your first UK home, a Help to Buy ISA is a MUST. Firstly, you’ll be paid an average rate of 2%-2.5% AER on your savings. Secondly – and most importantly, the UK government will top your savings up by 25%, up to a maximum of £12,000.
- Junior ISA: A Junior ISA operates much in the same way as a standard Cash ISA, insofar that you will be paid a rate of interest on your savings. The money cannot be accessed until your child turns 18, albeit, you can usually transfer your Junior ISA to another provider at any given time.
- Innovative Finance ISA: An Innovative Finance ISA allows you to invest money into peer-to-peer loans. While the rates of return are much higher than a conventional Cash ISA, as are the risks.
Why you should utilize your annual ISA allowance
Irrespective of what ISA suits your individual investment needs, the overarching takeaway is that a failure to utilize your annual allowance will ultimately cost you money. For example, let’s say that you currently have £25,000 saved in a traditional bank account. Firstly, with banks and building societies still paying record-low interest rates to savers, ISA accounts will in the vast majority of cases offer a more competitive return on your money.
Secondly – and as we have already discussed, you will also be accustomed to taxation on your bank account earnings. Alternatively, you could transfer £20,000 to a standard Cash ISA this year, and then transfer the remaining £5,000 balance in April 2020 once your annual allowance resets.
The savings that you can make by shifting your money from a standard bank account to that of an ISA remain constant regardless of which ISA you go with. Ultimately, by not using your annual allowance and instead deciding to invest your savings in a non-ISA based account, you are effectively losing money.