Published: 25 March 2022. Written by: Laura Whateley
Confused about ISAs? Laura Whateley, award-winning personal finance writer, explains the biggest misunderstandings, so you can start saving with confidence
There are many different types of ISAs, suitable for everything from saving for your first home or first baby, to investing for retirement or your child’s education. But they can seem complicated at first, not helped by common ISA myths. Here we bust the most common.
Myth #1 ISAs are only for the wealthy
Each tax year, which runs from 6 April to 5 April, you have a personal ISA allowance of £20,000. This is the maximum amount you can invest into ISAs in total during that tax year.
But you can still take advantage of ISAs even if you don’t have thousands of pounds in the bank. Cash ISAs can be opened with as little as £1 and can be topped up as little or as often as you like.
Even stocks and shares ISAs, which you can use to invest in the stock market, can be opened with modest amounts. Vitality’s stocks and shares ISA, for example, is available from as little as £50 a month.
The ISA allowance is use-it-or-lose-it, so if you don’t save £20,000 this year, you cannot roll over the allowance you didn’t use to the next year. But ISA accounts can grow over time. Even if you are starting small, you can take advantage of their tax benefits for years to come, however big your savings pot gets.
Myth #2 You can only have one ISA at a time
You only get one ISA allowance of £20,000 per tax year, but you can split that across different types of ISA accounts. For example, you could invest £10,000 in a cash ISA, and £10,000 in a stocks and shares ISA. Or max out the lifetime ISA, at £4,000 a year, to help you save towards retirement, and put the remaining £16,000 in a stocks and shares account.
You cannot open two of the same type of ISA in the same tax year. And if you have more than one ISA of the same type – say, a cash ISA that you opened a previous tax year and a different cash ISA opened in the current year – you can only pay into one of them at a time.
However, you can keep an old ISA open and transfer money into it from a new account, shopping around for the best rates, each time the year resets in April.
Myth #3 There is no point in ISAs because of the personal and dividend tax allowances
The biggest advantage of an ISA is that any return you earn on your savings or investments kept within them is tax-free.
Usually, you have to pay income tax on the interest you earn from cash savings, and on dividends from shares held; and capital gains tax on returns from selling stock market investments. However, this is much less common since the introduction of personal allowances.
The personal savings allowance enables basic-rate taxpayers to earn £1,000 in cash interest before paying tax, and higher-rate taxpayers £500. The dividends allowance means you can earn £2,000 without being liable for income tax. And for capital gains, the allowance is £12,300 when you sell assets such as shares. These allowances mean most people end up not paying tax on their savings anyway.
So do these allowances make ISAs pointless? Not necessarily.
ISAs are tax-free forever, meaning even if your savings are modest at the moment, if they grow over decades, all your savings inside them remain sheltered.
There’s also no guarantee the personal allowance will always be around, and the limits may change from year to year.
You may also get a pay rise and change tax bracket in the future; additional-rate taxpayers (those earning above £150,000) do not have a personal allowance for interest earned on cash savings.
Myth #4 I can’t touch my money once it’s in an ISA
Different types of ISAs, and different banks or financial companies that offer ISAs, have varied rules about when you can or can’t withdraw money. Easy-access cash ISAs, for example, are very flexible and you can take out your money when you like.
Lifetime ISAs have some rules about withdrawing cash. You will pay a penalty if you use your savings for anything other than buying your first home (which must be worth less than £450,000 to qualify), or withdrawing it for retirement when you reach 60.
Stocks and shares ISAs don’t have rules about when you can withdraw money – with Vitality’s, for example, you can take money out and put it back in, without losing any of the tax benefits.
But it is always sensible to invest for the long term, which means tucking away money you are prepared to leave alone. ‘Time is of the essence,’ says Roy McLoughlin, associate director of wealth management firm Cavendish Ware. ‘Stocks and shares ISAs are not appropriate for short-term savings; you need at least a three-to-five-years timeline before you want to access your money.’
Myth #5 Once you open an ISA, you’re stuck with it
You can only open one account per type of ISA per year, but that doesn’t mean you’re stuck with it forever. You can switch around the following year, or the year after. Look for ISAs that let you ‘transfer in’ funds from old ISAs.
Myth #6 Stocks and shares ISAs are only for experienced investors
Beginner investors are, in fact, exactly the group who should be taking advantage of stocks and shares ISAs. They shelter your money, so that any return you make on your investments is tax-free, forever, making them ideal to slowly grow your savings.
You can start by setting up a direct debit and feeding in small amounts regularly. There are some golden rules: invest for the medium-to-longer term and make sure you have a cash account for emergencies.
You should also diversify by investing in funds. If you’re unsure where to start, consider a ready-made portfolio within a stocks and shares ISA. Vitality offers a variety to choose from based on your appetite for risk.
The best-selling book Money: A User’s Guide is by Laura Whateley
Are you thinking about whether or not an ISA is right for you? Here are the answers to your question ‘Should I get a Stocks and Shares ISA?’