If you’re a taxpayer, you’ll be used to paying tax on any income derived from your savings. This is why ISAs are important – the returns are completely tax free. So, how do ISAs work?
(Disclaimer: due to changes in regulations, some of the details in this video are now outdated. The script below and our guide to New ISAs both reflect the changes to tax-free acounts.)
Every tax year, savers receive a tax-free allowance. From April 6, this was raised to £11,880. (It has since increased to £15,000.)
You can invest this allowance in cash, which is risk-free and acts like a normal savings accounts. You can invest it into a stocks and shares ISA, if you have an appetite for risk. Or, you can combine, investing some in cash, and some in stocks and shares, up to the maximum limit.
You’re only allowed to invest into one of each type of ISA in any given tax year.
In July 2014, major changes were made to the way that ISAs work. The allowance rose to £15,000, and for the first time, savers became able to invest all of this in cash.
Another advantage of ISAs is that they have cumulative benefits. Once you invest your funds into an ISA, they remain tax free for as long as you want them to.
This means that over several years, you can build up a stockpile of tax-free savings. You should note, however, that any money you withdraw from an ISA is no longer tax free.
If you withdraw money from an ISA or attempt to transfer your ISA funds manually, the cash will lose its tax-free status. Anything you pay back in will count towards your annual allowance.
Not Happy? Transfer Your ISA
But that doesn’t mean that you need to stick to the same account.
If the rate on your account is low or uncompetitive, instead of withdrawing funds from your ISA, you can transfer an ISA from one provider to another.
This doesn’t count towards your annual allowance, and it keeps all of your ISA funds tax free.
Fix for Better Rates
You can also boost your rate of return by locking funds away into a fixed-rate account. But be wary that you could face a loss of interest if you attempt to gain access to funds in a fixed rate product.
Your Yearly Allowance Doesn’t Carry Over
Invest what you can into your ISAs before the end of the tax year. At this point, any unused allowance will be gone forever.