ISA Fundamentals

Why you need to know
With a wide choice of investments that can underly an Individual Savings Account (ISA), and its tax efficiency, an ISA is often the first port of call for an investor, particularly for higher rate and additional rate taxpayers and those restricted as to the amount of tax-relievable pension contributions they can make or benefits they can accrue because of existing pension provision.
What you need to know

The ISA is basically a tax-free scheme for saving. For investors, the returns from ISA savings are free of UK income tax and capital gains tax. For this reason, income and capital gains do not have to be entered on a tax return and funds can be removed without a tax penalty.

With a maximum subscription of £20,000 per individual for tax year 2019/20, married couples/civil partners can currently jointly save £40,000 each tax year. If they saved this amount each year for ten years they would have a fund of almost £530,000 with fund growth at 5% compound per annum.

There are four types of ISAs available:
1. Cash ISAs (including Help to Buy)
2. Stocks and shares ISAs
3. Innovative finance ISAs
4. Lifetime ISA

The Help to Buy ISA, available from 1 December 2015, is a cash ISA for first-time house buyers (a maximum purchase price of £250,000 (£450,000 in London). The HTB ISA has a maximum subscription limit of £2,400 p.a. The Government pays a bonus of 25% of the amount subscribed each year (to a maximum bonus of £3,000) where the proceeds are used to purchase a first property for up to £250,000 (£450,000 in London). A HTB ISA can be transferred to a Lifetime ISA (see below).

The Lifetime ISA (LISA), available from 6 April 2017 has a maximum subscription limit of £4,000 in 2019/20. It is available for investors aged up to 39 and no further subscriptions can be paid once the investor reaches age 50. The Government adds a bonus of 25% of the amount subscribed each year, although this bonus and any associated growth is clawed back, with an additional penalty of 5%, if money is withdrawn before age 60, except for the purposes of buying a first house with a purchase price of up to £450,000. LISA subscriptions can be invested in cash or stocks and shares in any proportion. If an investor also holds a Help to Buy ISA, only one 25% Government bonus is payable – the investor can elect which account receives it.

The Innovative Finance ISA was introduced from 6 April 2016 and is designed to allow investors to lend all or some of their annual subscription allowance through peer to peer (P2P) lending schemes (also known as crowdlending).

A cash ISA, stocks and shares ISA, LISA and Innovative Finance ISA can all be with the same or different providers. A cash ISA can be switched, in whole or in part, to a stocks and shares ISA and vice versa.

Permitted investments for ISAs are prescribed in the ISA regulations.

For a stocks and shares ISA, the permitted investments include quoted stocks and shares, AIM shares, collectives, such as unit trusts and OEICs, and corporate bonds.

Permitted investments for a cash ISA include cash deposits and certain cash-based collectives.

Tax fundamentals
• No UK tax on dividends in a stocks and shares ISA (although tax credits – that were applicable for years up to and including 2015/16 – could not be reclaimed). Tax credits were abolished with effect from 6 April 2016.
• Interest is received free of UK tax in all ISAs.
• There is no capital gains tax on profits.
• ISA income and gains do not have to be reported on a tax return and are ignored for the High Income Child Benefit tax charge and Personal Allowance / Tapered Annual Allowance income threshold calculations.
• ISA transfers can be made between the cash and stocks and shares components and vice versa, with no restrictions or tax implications.
• AIM shares held in an ISA are subject to the normal inheritance tax (IHT) rules and can therefore qualify for 100% IHT business relief after two years of ownership.

Death of an ISA investor
On death income and capital gains which arise from the date of death cease to be tax exempt.

Benefits can be paid out by the ISA manager in the form of:
• Cash;
• the transfer of investment assets underlying the ISA to the deceased investor’s estate.

The value of an ISA at death will always form part of a deceased investor’s estate as an ISA cannot be gifted or assigned into trust so as to change legal ownership.  A surviving spouse/civil partner will be entitled to make an additional permitted subscription (see section on “eligibility” above).

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