Why consider investing in an Individual Savings Account (ISA)?

What are the tax advantages of ISAs?

Choosing to invest outside of an ISA could be very costly, particularly if you’re a long-term saver. The table below shows the rate at which income and capital gains are taxed above your individual allowance, on investments outside of an ISA. Comparing those rates to the 0% tax on ISAs, demonstrates the potential savings.

Tax rates 2023/24

* Residential property rates are not shown here as this asset class cannot be held within an ISA.

Sustained investment in an ISA can see capital accumulate, the more so with the reinvestment of the tax-free dividends and interest. As the capital accumulates, you’ll see more of the tax-saving benefit over time.

Lifetime ISA

The Lifetime ISA is a special type of ISA in that it is flexible in terms of the mixture of cash, stocks and shares it can contain, and is used for saving for the purchase of a first home or for later in life, such as your retirement. You must be between the ages of 18 and 40 to open one, while the maximum contributions you can make per year is £4,000 until the age of 50, after which you can no longer pay in. Any payments into a Lifetime ISA also count towards your £20,000 annual ISA limit. The government will add a 25% bonus to contributions up to a maximum of £1,000 per year.

There are three circumstances in which money can be withdrawn from a lifetime ISA, which are if you’re:

• Aged over 60;
• Buying your first home; or
• Terminally ill, with less than 12 months to live.

In any other case, a 25% charge will be due when withdrawing funds in order to recover the government bonus. This makes the Lifetime ISA an ineffective way to save short-term.

Junior ISAs 

Junior ISAs (JISA) come in two types - a cash JISA or a stocks and shares JISA – and children can have one or both types.

Children are eligible for a JISA if they’re under 18 and living in the UK, although there are exceptions for children of Crown servants living outside the UK. If you’re a parent or guardian with parental responsibility, you can open a JISA and manage the account, but the money belongs to the child, who can take control of the account when they reach 16. They cannot, however, withdraw the money until they turn 18.

While anyone can pay into the JISA, contributions are limited to an annual cap (£9,000 in 2023/24) which can be split between two ISAs. Once paid in, money can be transferred between JISAs and a Child Trust Fund account freely, but not into an adult ISA. JISAs automatically turn into an adult ISA when the child turns 18 and remain exempt from tax.

Gifts to children ordinarily cause complications because of the parental settlement rule. If the gift generates gross income above £100, be it interest or dividends, all the income is taxed on the parent who made the gift. Gifting into a JISA circumvents this risk, meaning parents do not suffer a tax liability from income generated by assets in their children’s name.

Can you move an existing portfolio into an ISA?

Stocks and shares ISAs only allow the introduction of cash, not existing holdings of shares, but there is the alternative strategy, known as bed and ISA, which entails the disposal of a portfolio before transferring the cash into the ISA and then using the cash to repurchase the shares. This may realise a capital gain but given the annual allowance for ISAs is only £20,000, most gains may be under your annual exemption (£12,300 for 2022/23), assuming you have no other gains. If you routinely realise significant capital gains in your personal capacity, the tax can be considerable, but there is scope for you to coordinate the realisation of gains with utilisation of the annual exemption.

Taxation of ISAs on death

While gains and income produced within ISAs are not subject to tax, the value of an ISA still forms part of your estate and is potentially subject to Inheritance Tax (IHT) at 40%. You can mitigate this liability by transferring your ISA to your spouse or civil partner on death under the terms of your will, which is covered by the IHT inter-spouse exemption. The ISA must be transferred into their own name within 180 days of the beneficial interest being transferred to them by the executors. The ISA will remain free from income and Capital Gains Tax for your spouse/civil partner and can be consolidated with an existing ISA.  

If your ISA funds are bequeathed to someone other than your spouse/civil partner in your will, the transfer of the value of the ISA will not be exempt from IHT. However, your spouse/civil partner can elect to take an additional ISA allowance equivalent to the value of the your ISA, although this would require your spouse/civil partner use their own funds to utilise this additional ISA allowance. An election has to take place within 180 days of the administration of your estate being completed or by the end of three years after death, whichever is later. 

ISAs retain their tax-free status for up to three years from the date of death, so income and gains realised in the administration period of the estate will be exempt for the Executors. 

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