One of the most amazing free gifts we get in the UK is an ISA (Individual Savings Account). This is a cool tax free savings wrapper, protecting you from having to pay tax on any future gains or income. There are however some strings attached to this generous gift. An ISA has an annual allowance that you need to use or you lose it. Hence my call to make sure you are managing your allowance each and every year. [Note: This post is very UK centric, feel free to skip if you are from another country and have no interest in UK taxation and savings incentives.]
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What is an ISA?
An ISA is a wrapper, that allows you to save or invest tax free. That means you do not have to pay tax on interest (from a cash ISA) or either dividends or capital gains (from a stocks and shares ISA). So you can shelter your income and capital gains from HMRC legally. This is a government devised method to reduce your tax bill. As an additional benefit you don’t even need to report it on your tax returns so they actually make the tax regime more simple.
There are different types of ISA available with the most common and original versions being the Cash and Stocks and Shares. Nowadays the options have multiplied; with the Junior, Help to Buy, Lifetime and Innovative Finance coming into being. The newer ISA’s just add additional complication and the odd bonus. I don’t think they actually benefit the majority of people, and feel the government should concentrate on simplification rather than compilation. My personal opinion is that Stocks and Shares ISA is the master. This allows you to invest rather than save, and historically the stock market has outperformed cash. You can read about my evolution to an investor here. This blog is never going to be a guidebook, hence I defer to the masters at explaining all the details, much more eloquently than I could.
For a full and very detailed guide, here is the MoneySavingExpert article.
And here is the government guidance on ISAs.
Finally the Motley Fool also have a guide.
So the idea of a tax free wrapper sounds very generous, but surely they are some catches? Yes, every individual has an annual allowance. This year’s ISA allowance is £20k. Which I’m sure you will agree is a very generous amount. But here is the catch, this is a use it or lose it allowance. That’s right, you have to use each years’ allowance, or you will lose it. There is no roll over possible (unlike pensions, where you can use carry forward).
No other country offers such a generous tax exempt savings scheme. Although you could argue that this is due to our relatively high tax burden here in the UK. I see it as a clear indication, that the government want us all to save and invest more, hence they are offering us tax incentives to do so. Also to note, ISAs are a UK tax incentive, that doesn’t cross borders well. For example Americans in the UK still have to pay US tax on them, so please take your own circumstances into account.
Why you should Use it
Your personal allowance is an annual gift from the government and HMRC. This sort of gift is very rare, and shouldn’t be sniffed at. And the beauty of the ISA is that the wrapper works for life, so you are saving yourself tax this year, next year and so on on all those glorious compounded gains. This can add up to be a lot of future tax saved. So if you have the funds, you should definitely think about using your ISA. You can pay into an ISA from your income, or move existing savings and investments into an ISA wrapper for the future.
Don’t Lose it
Don’t delay, you still have time to act. You can find and open an ISA before the end of the tax year on the 5th April. Here is the call to action, there are only a few weeks left to get things sorted. Do you want to open an ISA? Do you want to top up your ISA? Now is the time to evaluate your finances and manage your annual allowance. If you don’t manage it, you will lose this years allowance in a few weeks time. And once it’s gone, you can never get it back.
How I use ISAs
I personally love the ISA wrappers. Given I have a high income and a high savings rate I am able to make full use of my ISA allowance. Since my investment approach is KISS (keep it simple stupid), I only have one ISA. Yes only one, and it is a stocks and shares ISA. I have transferred all my previous ISAs, even those that were cash, into this ISA. I practise what I preach on simplicity, it makes my day to day and keeping track so much easier.
At the start of the tax year I make monthly contributions to my stocks and shares ISA until I meet the annual limit. Then when I reach the limit I change to investing in my taxable account. I make sure I use the allowance each year, as I don’t want to lose it.
Over to you
- Have you got an ISA?
- What variety do you have, cash, stocks and shares or a new one?
- Have you filled it as much as possible?
- If you are not in the UK, do you have a similar tax incentivised savings scheme?