When you invest your money, it’s vital to make use of tax allowances. Individual Savings Accounts – or ISAs – are often a first port of call owing to their simplicity and flexibility. There are several types, notably Cash ISAs and Stocks & Shares ISAs.
Cash ISAs are like a tax free bank or building society account, whereas Stocks & Shares ISAs give you the opportunity to grow your money over the long term in the stock market and other assets – meaning your capital is at risk. If you use an ISA, any money you make – either interest on cash or investment income or gains – is free from tax, which can be really important for your long-term returns.
While ISAs in general are familiar to many people, there are several lesser-known rules, flexibilities and techniques that help investors manage their financial affairs in a way that suits their needs. Here’s an overview of some of the ISA rules that can make your financial life easier.
Five ISA rules that make your financial life easier
1. Transfer a Cash ISA to a Stocks & Shares ISA and vice versa
Cash ISAs can be transferred between providers, but many investors do not realise it is also possible to switch from a Cash ISA to a Stocks and Shares ISA without losing the valuable tax-free status of their savings. You can also switch the other way, from Stocks & Shares to Cash, if your needs change.
For some, Cash ISAs may have become less useful. The personal savings allowance means a basic rate taxpayer can earn up to £1,000 from ordinary bank or building society accounts tax free anyway, while higher rate taxpayers can earn up to £500 tax free. This means many people no longer pay tax on their savings interest on ordinary bank and building society accounts. Over the longer term, tax-efficient allowances are generally best prioritised for assets that produce a higher level of return, either through income or capital gain.
The possibility of transferring from a Cash ISA to a Stocks & Shares ISA (and vice-versa) is a valuable flexibility not to be overlooked. The stock market offers greater opportunity to grow your money and has historically performed better than cash over the long term. If you have not invested before, you can use Cash ISAs (or a portion of it) to get started and build the foundations of an investment portfolio. If you are already an investor, you can use it to add to one.
2. Take tax free withdrawals whenever you like
Whatever retirement looks like for you, investing wisely is likely to be a key factor in achieving it. Pensions are usually the most efficient way to provide for your later years. You can benefit from the addition of a government payment, known as tax relief, when you pay in, plus, if you are employed, you receive payments into your Workplace scheme from your employer – so this should be a priority.
Pensions can’t be accessed until a minimum age. Currently this is 55, but it is set to rise – to 57 from 2028. For those looking to retire or supplement their income before this age, ISAs could be an option to bridge the early retirement gap. Withdrawals from ISAs, in addition to being tax free, can be made at any age, making them a potential stop gap.
3. Withdraw and replace money when you like with a Flexible ISA
The lesser-known ‘Flexible ISA’ rules mean you can withdraw money from an ISA and return it in the same tax year, 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, even if it’s worth several hundred thousand pounds, and replace it by 5 April. 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 April, without affecting your allowance. It is possible to have a Cash ISA or Stocks & Shares flexible ISA as long as your provider supports it (not all do!), but bear in mind that you can’t subscribe to more than one of the same type of ISA in a single tax year, and you can only repay withdrawals to the same ISA they were taken from.
4. ‘Bed and ISA’: Shelter your shareholdings from tax and use your CGT allowance
Those with significant capital gains, and therefore potential tax liabilities, could consider taking advantage of this tax year’s higher CGT allowance by selling down investments. You’ll need to do so before the end of the tax year on 5 April, as you can’t carry it forward to next year when the current £12,300 allowance drops to £6,000.
One option for existing shareholdings is a ‘Bed & ISA’ which can help use your CGT and ISA allowances simultaneously. It involves selling holdings and then buying them back in an ISA account. The sale creates a capital gain (or loss), and selling or partially selling an existing investment could help with tax planning by using some of your capital gains allowance while keeping your holding.
As well as harvesting capital gains while maintaining existing investments, a Bed & ISA can be used to tidy up small or non-tax-efficient parts of your portfolio or make more of neglected holdings. It could also reduce the work required to complete your tax return in the future.
5. APS: Extra tax shelter for your spouse or partner on your death
If an ISA holder dies, the assets are left to the beneficiaries of their estate – according to the specifications of their will or, if there isn’t one, according to the rules of intestacy. No matter how the assets are divided, in most cases a surviving spouse or civil partner can ‘inherit’ the tax benefits of the ISA, as well as the investments themselves if applicable.
Introduced in April 2015, an additional permitted subscriptions (or APS) are one-off ISA allowances available to the surviving spouse or civil partner that can be made in addition to their annual ISA allowance. The additional permitted subscription is equal to the total value of the deceased’s ISA accounts. APSs can be made to a new or existing ISA of their choosing.
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