Hi everyone! I hope you had a positive week! As we get closer to the tax year end on the 5th April 2021 and is quickly upon us. Having discussed with family members who are thinking about the most efficient way to save and earn some interest, I thought I would delve into the wonderful world of ISAs but you will need to act quickly to make the most of your allowance. The purpose of this post is to share what I know and what I have researched so everyone can grow their pot of savings!
Please note that I am not a financial advisor, so the tips and information below is not financial advice. I would recommend that you perform your own independent research and/or speak with a qualified investment professional before making any financial decisions.
What is an ISA?
ISA stands for Individual Savings Accounts and there are four different types in the UK:
- Cash ISA
- Stock and Shares ISA
- Innovative Finance ISA
- Lifetime ISA
- Junior ISA
For the purposes of this post, I will focus more on Cash and Stock & Share ISAs . For the tax year ending 5 April 2021, you can save up to £20,000 in one type of account or split the allowance across the different type of ISAs. For example, you could save £15,000 in a cash ISA, £2,000 in a stocks and shares ISA and £3,000 in an innovative finance ISA in one tax year. The great things about ISAs is that if you save £20,000 this year, it will not close after the 5th April 20201 and you can keep saving the allowance each year and it is tax free as long as you keep it in an ISA. You can imagine how quickly that pot can grow, I mean ISA millionaires is a thing! (One can certainly dream to get there).
Make sure you use up your ISA allowance as much as possible. Currently, I am not able to save up the whole allowances so this is why I am trying to save more and put it into my ISA than contribute to my pension. This really depends on each person and how generous your employer’s contribution is. However, the reason I am saving more into my ISA than my pension is because your pension is only accessible after a certain age, and there are now all these complicated rules about getting it out lump sump/treated as income etc. At least with an ISA, you have have access to it whatever the age and when you need the money you can usually take it out. The only exception is fixed ISA where they might charge you a penalty if you take it out before the end date, but if you don’t have then, then its all good. The benefit of saving into an ISA and then not touching it, you will benefit from the effects of compound interest and it is all tax free and that makes it incredibly attractive! Being an ISA millionaire – here I come!
Personal Saving Allowance
This was launched in 2016 and it means that all saving interest is now automatically paid tax free (whey!). Each year, Basic 20% rate taxpayers can earn up to £1,000 interest a year without needing to pay tax on it, higher 40% rate taxpayers £500 and top 45% rate taxpayers must pay taxes on all savings. Given the dismal interest rate environment we are in, it is very likely that you will not meet the threshold so the question you should ask yourself is what product will give you the highest return/interest. If you don’t mind tying your money up, this usually mean fixed rate interest, but I mean they are around c.1% which is not that impressive at all especially when you take into account inflation!
Why open an ISA?
An ISA is more beneficial for high rate taxpayers and big savers. Money Saving Expert (“MSE”) does a great comparison on the benefits of an ISA.
- Basic-rate taxpayers over the PSA limit (£1,000), for every £100 interest you earn in normal savings you only get £80, whereas in an ISA you get the whole £100. Therefore, the normal savings rate would have to be 25% higher for it to beat a cash ISA. In order to assess whether your normal account savings is actually giving you a higher rate of return, you have to compare the ISA rate x 1.25 with the interest rate of your savings account. For example, if your ISA is giving you 0.4% but your cash savings account is giving you 0.6%. To compare which is better, ISA is 0.5% (0.4% * 1.25) vs. Savings Account 1%. In this case, it is still better to go with the savings account.
- Higher-rate taxpayers over the PSA limit (£500). For every £100 interest you earn in normal savings you only get £60, whereas in an ISA you get the whole £100. Therefore, the normal savings rate would have to be 66% higher for it to beat a cash ISA. Therefore, to check which is giving you a better deal using the same numbers as above ISA is 0.4% * 1.66 = 0.664% vs. 0.6%, therefore, you are better off in an ISA.
- Top-rate taxpayers all your savings gets taxed. Therefore, for every £100 interest you earn in normal savings you only get £55, whereas, in an ISA you get the whole £100. Therefore the normal savings rate would have to be 82% higher for it to beat a cash ISA. ISA rate is 0.4% * 1.82 = 0.728% vs 0.6%, again, you are better off in an ISA.
The above is only applicable if you are over the PSA, which I know that for most people this probably is not very relevant because after doing some quick maths, in order to earn £1,000 a year and assuming interest rate of 0.4% (what most banks are paying currently), you need a balance of £250,000; or half that if you are a higher rate tax payer. Not sure about my readers but I certainly do not have that kind of money lying around in various bank accounts. However, if we believe that interest rate is going to rise in the future, then saving in an ISA now can protect you from future tax because you are using up the allowance every year and it is will be tax free as long as it stays in an ISA. Conclusion: just open an ISA!
Cash ISAs have become flexible
Now this came as a surprise to my sister, so I want to make it clear here first. For most cash ISAs, if you withdraw money and then replace it, the money you put back reduces your allowance for the tax year. For example, you put £10,000 into a new cash ISA but your boiler breaks (which happened very recently and I still feel the pain of taking out my £££) you take out £4,000 to pay for it. If you have an non-flexible ISA, your ISA allowance used is still £10,000 even though you only have £6,000 in your ISA.
However, if you have a flexible ISA, it will consider your allowance used only to be £6,000 so you can still put in a further £14,000 in the tax year to use up the limit of £20,000! This is a a game changer and makes a difference if you often move money around or use an ISA similar to a flexible current account – for a list of providers, please see here. However, you will notice that most of our high street banks don’t give that option (BOO!); so do shop around and find what is right for you.
Transfer your ISA
The great thing about ISAs is that you can transfer them anywhere you like, which you should, as you want to seek the highest return for your money. Before you do, however, you just need to check whether the new provider allows old ISAs to be transferred into it. Top tip – if you want to transfer an ISA, NEVER WITHDRAW THE MONEY because you will lose all the tax benefits. Make sure you fill in an ISA transfer form to keep your ISA permanently tax free. It normally takes about 15 days, so given that we are very close to the tax year end, my recommendation is just to put money into your current ISA (if you have one) so you can use up the allowance as much as possible and then shop around for the best rates so that you can put a further £20k in the next tax year.
You are also able to consolidate all your old ISAs into one new one, just let the new provider know that you want to transfer from multiple old ISAs. The only thing to keep in mind is that you do not want all your money in one financial institution over £85,000, if not, anything over £85,000 is not guaranteed. For those with the dough and want a peace of mind, spread your money around.
For the top easy-access cash ISAs and top fixed rate cash ISAs see a list here.
For more information on stock and share ISAs see a list here. One of the key things to consider for Stock and Share ISAs are management fees because this is what will eat into your returns. From my understanding, one of the cheapest is Vanguard.
I hope you found this post useful, there is a wealth of information out there and it can be pretty scary navigating ISAs, however, if you want a more detail guide, please check out this post from MSE. I am happy to answer any questions so feel free to leave me a comment below or email me on firstname.lastname@example.org!
With Sweet and Sour Love,
Pineapple Chicken x