Individual Savings Accounts (ISAs)

These function like savings or investment accounts, but with additional benefits. Any increase in your money, from interest on savings or gains on investments, are tax free forever. You do not need to declare the growth on your tax return.

4 Main Types:

1. Cash ISA

2. Stocks and Shares ISA

3. Lifetime ISA or LISA

4. Innovative Finance ISA

You can open one of each type of ISA per financial year (6th April to 5th April) with different amounts saved in each up to the annual limit of £20,000 across all accounts. You can have multiple ISAs of each type open (for example 2 cash ISAs), but you can only pay into one each financial year.

What is a LISA?

A tax-free account aimed at those saving for their first home or for retirement.

It replaces the Help to Buy ISA (ended November 2019). (If you have a Help to Buy ISA you can use this until 20 November 2029 and are able to claim the bonus until 1st December 2030. You can transfer to a LISA with no penalty, but if you transfer from a LISA to Help to Buy ISA you will be charged 25%.)

Types of LISA

Limit

£4,000 per financial year. This goes towards your annual ISA allowance of £20,000 across all types of ISAs. Any bonus, interest or investment growth does not count towards the annual allowance.

If you don’t use the allowance it is not carried forward into future years; you may see prompts to fill up your ISA allowance for the year. Once contributed it can stay in the account indefinitely, and once a new financial year starts you can add money again under the new allowance.

Benefit

25% bonus on the money you contribute, paid monthly from the government in 4-8 weeks. If you invest the full £4,000 you would receive £1,000 per year. The maximum bonus is £32,000 over the lifetime.

Any interest earned on the account or increase in investments are also tax free. The bonus is added to the contributions and either invested or interest earned on this amount.

There is no tax paid when you withdraw the money when you are over 60.

Eligibility

LISA’s are available for UK residents (or part of the crown service) aged 18-40. You can pay into the account until you are 50. After 50 you cannot add money or receive the bonus, however you will still get growth from interest or investments.

When can you access the money?

Criteria on buying a home, it must:

You can only use the government bonus once to purchase your home if you also have a Help to Buy ISA. If you use your LISA to buy your home you can also keep it for retirement and continue receiving the bonus.

If the money is withdrawn for any other reason, you pay a 25% fee. This does not simply mean the 25% bonus is returned, it includes the bonus and the interest or investment growth.

Example

If you contributed £4,000 giving you a £1,000 bonus and an interest rate of 2% giving you £80. In total you have £5,080. The 25% withdrawal fee is on the whole balance and would cost £1,270 leaving you £3,810 – less than you contributed. How much you get back with a stocks and shares ISA also depends on how the investments performed.

What if you are a couple?

You can both have a LISA and each get the benefit. Or if only one of you opens a LISA then you will get the benefit of the one account and only that individual needs to meet the criteria.

Is your money protected?

Cash LISA

If your money is in a cash LISA then it is protected up to £85,000 across all accounts (current accounts, savings, LISA etc) with each financial institution (UK bank or building society) if they go bust. This is part of the FSCS (Financial Services Compensation Scheme) and is a regulation by the UK Prudential Authority.

If a financial provider has multiple brands, for example HSBC and First Direct you are only protected for £85,000 across all brands (because they share 1 banking license). Therefore, it is better not to have more than £85,000 across all accounts with one financial institution.

Stocks and Shares LISA

If your money is in a Stocks and Shares LISA it is a little more complicated. Your investments themselves, and therefore your money is at risk. For example, if the company you invest in goes bust you will lose that money. The provider should hold your investments separately to their own money so if they go bust in theory your investments themselves should still be there; although it will take time to get them back and the administrators could charge a fee.

In addition, the same protection of £85,000 is granted if the financial institution goes bust. If you invest instead through a UK based broker you are covered up to £50,000 per person of investments that cannot be recovered from the broker which has gone bust. For example you are owed £50,000, the broker returns you £30,000 and the FSCS will give you £20,000. This could happen for many reasons, for example fraud.

Can you transfer your ISA?

You can have different ISAs open with different providers that you contributed to in previous financial years. To keep it simple you can transfer old ISAs to combine them – to a different type or the same type. If you transfer a different type into a LISA this counts towards the £4,000 limit, but this will not necessarily count towards your £20,000 annual limit if the money was invested using a previous allowance in an earlier financial year.

If you want to transfer money you’ve invested in an ISA during the current year, you must transfer all of it. For money you invested in previous years, you can transfer all or part of it.

Make sure you never withdraw the cash but fill in ISA transfer forms (otherwise reinvesting it will count towards the annual limit), the process takes around two weeks. Transferring ISAs means its easier to keep track of your money and you get a better interest rate or investments available. Some providers have a penalty for moving your ISA, while others don’t allow transfers in – you will need to check.

Should you invest in a cash LISA or a stocks and shares LISA?

Consider your timeframe, goals and risk tolerance. On average investments outperform cash over the long term so there is potential for a higher return, however they are riskier.

Cash LISAs are more likely to suit you if you are:

– More risk averse

– Saving for something specific

– Need the money within a shorter timeframe (typically less than 5 years)

Stocks and Shares LISAs are more likely to suit you if you are:

– Comfortable with the value of your investment going up and down

– Accepting of some risk, with the possibility of losing your money if the investments decrease in value or the stock market crashes

– Investing for the longer term (typically more than 5 years)

– Willing to pay investment fees

Should you add money to your pension or a LISA?

The LISA is not a replacement to your workplace pension, but can be complimentary.

For most individuals paying more into a pension would be better than a LISA when saving for retirement.

This is in part due to employer contributions; companies will pay at least 3% into your pension and will often match further contributions up to a certain amount. For example they might match up to 7%, which means if you pay in 7% or higher they will pay in 7% too.

This is also due to the tax relief you receive when you pay into your pension; the government will contribute 20%, 40% or 45% depending on your tax bracket instead of taking it as tax. This is increased if you pay through “salary sacrifice” on your pre taxed income and also receive national insurance relief.

Pensions do better as they are not considered when calculating your benefit entitlement, aren’t included in inheritance tax and are protected from bankruptcy – the opposite is true for LISAs. Pensions have a higher annual limit of £40,000 and can be accessed at state pension age (currently 55). Where the LISA does better is tax free withdrawals post aged 60; pensions offer 25% tax free withdrawal and the remainder is subject to income tax.