How ISAs can help you through your financial life

ISAs – or Individual Savings Accounts – are widely recognised by investors for their flexibility and tax efficiency. There’s no tax to pay on any interest or investment returns on anything housed by an ISA, and you can get to your money easily if you need to.

The annual ISA allowance of £20,000 can be used in a variety of ways according to a person’s needs and priorities. In fact, they are so versatile there’s few financial goals where an ISA wouldn’t be considered as part of the solution. It’s the Swiss army knife of financial planning – there’s a tool for almost every situation!

Building financial resilience early on

You can only earn a limited amount in interest from cash and certain investments tax free. For most people this ‘personal savings allowance’ is £1,000, but it’s only £500 for higher rate tax payers, and additional rate tax payers do not get an allowance at all.

If you are a basic rate taxpayer, you only need to have £20,000 in savings attracting an average rate of 5% to use up your personal savings allowance of £1,000. After that tax will start to nibble away at your returns.

It therefore makes sense to consider a Cash ISA for your savings, whether that’s for a short-term goal such as a holiday, wedding, or big-ticket purchase like a car. You could also consider a Cash ISA for housing your emergency fund so long as it’s an easy access account that you can get to at short notice.

Saving for a deposit on a first home

Buying a home is among almost everyone’s life goals. There’s considerable security that comes from owning your own place, and there’s a special ISA that offers a helping hand towards it.

Lifetime ISAs (LISAs) are for those saving for a home or retirement fund and allow those eligible to save up to £4,000 a year. The government pays in £1 for every £4 you save to provide a quick boost to your cash.

The Lifetime ISA can form up to £4,000 of the £20,000 ISA allowance for those aged between 18 and 40. It is possible to contribute up to the age of 50 and withdrawals are penalty-free if used for an eligible house purchase, or from age 60.

A Cash LISA generally makes sense for a house purchase if it’s likely to be within a five-year timeframe. Whereas when using a LISA to save for retirement it’s generally preferable to opt for the Stocks & Shares variety to maximise growth potential over a longer time horizon – although investments can fall as well as rise. Once you have used the LISA part of the ISA allowance with either of these goals in mind you can top up a standard ISA to the annual limit.

Pivoting to medium- or longer-term goals

Cash ISAs can work well for short term savings goals, but for longer term goals more than five years away investing is likely to be more appropriate. If you have built up all you need in cash, then it’s possible to repurpose some of your Cash ISAs to investing by transferring to a Stocks & Shares ISA where you can put it to work in the stock market and other assets for longer term goals such as providing for retirement.

It’s also possible to transfer the other way – from Stocks & Shares to Cash – which can be helpful if you have a medium-term goal such as providing for school fees or university costs. As it draws closer you can remove the risk of market movements impacting the value by transferring in part or whole to cash, which ensures the value won’t fall.

Investing for a new generation

ISAs are truly intergenerational, and it’s not just adults that have an allowance, kids do too. The Junior ISA (JISA) allowance is smaller at £9,000 a year, but using this allowance habitually can still add up to a handsome sum if invested well.

The tax benefits are the same as an adult ISA, so the child doesn’t have to pay any income tax or capital gains tax. A parent or legal guardian can set it up and can choose from a wide range of assets to take advantage of global investment opportunities and maximise growth. Other family members or friends can also add to the pot on behalf of a child to help give them a financial head start.

Once the child reaches 18, the account matures and rolls into an adult ISA and they can access the money. It can therefore be handy to fund university fees, travel or a new car – or it could help form the cash reserve or house deposit fund described above.

How ISAs can form a retirement ‘bridge’

ISA allowances that have built up over the years can always be used for shorter or medium-term goals as needed, but anything that remains can be directed at providing for retirement – and here they can be highly useful in providing extra flexibility.

Pensions such as SIPPs may have the edge over ISAs in terms of tax efficiency since they come with upfront tax relief as well as offering tax free returns while money is invested. But ISAs can work with pensions as a winning team.

Pension income is taxable, generally beyond the first 25% of the pot, while you can withdraw tax free from ISAs. You also need to wait until 55 (rising to 57) to access your money from a personal pension, whereas with an ISA (other than a Lifetime ISA) you can dip in at any time.

This makes ISAs a potential bridge into retirement, to supplement semi-retirement for example, or to provide a stop gap of income for a few years before the pension tap can be turned on. Alternatively, you can mix and match tax free income from your ISAs and taxable income from pensions to optimise tax efficiency. We weigh up the pros and cons of using and ISAs and pensions for retirement here.

Funding your ISA can therefore be a multi-decade, multi-function exercise. The earlier you start contributing, and the more you put away, the greater the options you have. You can adapt and repurpose your ISAs to different goals over different timescales, all while staying tax efficient with no reporting to HMRC. This is why we always emphasise that you should use your allowance as far as possible. While it may not be valuable to you today, it may well be further down the line.

A further dimension: the flexible ISA

There’s sometimes an obscure tool on a Swiss army knife that suddenly comes in handy. Similarly, the lesser-known ‘flexible ISA’ rules can allow for even greater versatility for investors – if you use an ISA provider that accommodates them such as Charles Stanley that is.

With a flexible ISA you can withdraw money and return it, without it counting towards your current allowance, provided you pay it back in the same tax year.

For example, let’s say you currently have £50,000 in your ISA accumulated from previous tax years. If you then withdraw £10,000, you can pay this back into the ISA during this tax year and still use your full £20,000 annual allowance before 5 April 2023.

It is even possible to withdraw the entire balance from your ISA built up over the years, even if it’s worth several hundred thousand pounds, and replace it by 5th April. This could be handy to fund a particular requirement right away when you know you can replace the money in the months ahead. It is important to note that if you fail to replace it by the end of the tax year, you will lose the ability to return the balance to your ISA without impacting your annual allowance.

Flexible ISA rules also cover any dividend payments withdrawn to a bank account during the tax year. You’ll be able to pay such amounts back into a flexible ISA if you want to by 5^th April, without affecting your allowance. It is possible to have a Cash ISA or Stocks & Shares flexible ISA if your provider supports it (few do!), but bear in mind you can only repay withdrawals to the same ISA they were taken from.

The information in this article is based on our understanding of UK Legislation, Taxation and HMRC guidance, all of which are subject to change.