The Individual Savings Allowance (ISA) is a popular savings vehicle as it provides a tax-free wrapper for your money, meaning you don’t pay tax on any interest you gain. Nor are you liable for tax on any income or capital gains from investments in an ISA.
And since April 2024, the rule that you could only subscribe to one type of ISA within the same tax year has been relaxed. So, you can now split your annual allowance across a cash ISA, a stocks and shares ISA and an innovative finance ISA. You could also have two cash ISAs (within the allowance) and choose ISAs with different providers.
Nonetheless, there are still six common mistakes that people make. Check out the rules in this article so you don’t experience the same issues.
1) Not maximising your allowance
You have an ISA allowance of £20,000 per tax year, so the most significant mistake is not taking advantage of this tax-free wrapper. Remember, you can pay into your ISA throughout the year. So, if you have sufficient funds, you should make contributions until you have maximised your allowance.
It works on a ‘use it or lose it’ basis, which means you can’t carry an unused amount over to the following year. Make sure you make any transactions by midnight of 5 April at the end of the tax year, but preferably well before then.
2) Going over the limit
Another common mistake is paying too much into an ISA in one tax year and exceeding the £20,000 limit. This can be easily done, especially if you have ISAs with different providers.
However, if you make this mistake, don’t just try to withdraw the money yourself. Call HMRC’s ISA helpline on 0300 200 3300. They will determine which ISA exceeded the limit, reclaim the money, and charge you any tax owed.
You can also only contribute £4,000 per tax year to a Lifetime ISA (LISA) which counts as part of your £20,000 allowance.
3) Choosing the wrong type of ISA for your goals
Make sure you think about why you’re putting your money into an ISA. If you think you will need access to the funds within five years, choose a cash ISA that meets your short-term goals.
However, if you’re hoping to achieve higher returns to support your child through university or fund your retirement, a stocks and shares ISA may be more appropriate. You just need to be prepared to invest for the long term (over five years) to allow for the ups and downs of the stock market. But, it’s worth noting, that although stocks and shares ISAs are designed for the long term, your money isn’t locked away so it is still accessible if you need it.
Be aware that you may have put your contributions into a fixed-rate cash ISA. This could mean you’re unable to access your money for a set term or will be penalised for withdrawals. Read the small print, if you find you do need the money, as you may be able to withdraw early but have to pay an early access charge. And if you’ve only just opened an ISA, there is usually a 14-day cooling-off period.
An innovative finance ISA lets you invest by directly lending money to borrowers and businesses. The borrowers then pay back the borrowed amount with interest on top. Any money that hasn’t been loaned out can be returned, but you may have to wait until the loans can be sold on to someone else.
A lifetime ISA is good for younger savers aiming to purchase their first home or save for later life. It lets them save up to £4,000 a year with a government bonus of up to 25% of the money invested up to the maximum of £1,000 a year. Note, however, there is a heavy penalty, if they want to access their money early.
4) Cashing in your ISA instead of making a transfer
You may decide to move your ISA to take advantage of better interest rates or promotional offers. In such a case, you need to transfer the money to the new ISA instead of closing the account and opening a different one. Otherwise, you could end up eating into your annual ISA allowance unnecessarily.
That’s because, by closing the account and making a contribution to your new ISA, your money loses its tax-free status, This counts towards your £20,000 annual ISA allowance which is not the case for transfers.
5) Thinking you have to invest in your stocks and shares ISA straightaway
You may be so concerned about maximising your allowance in an investment ISA that you think you have to invest the money right away.
But, as long as you meet the 5 April deadline, you can add your money to an ISA in cash and take your time to consider your exact investment selection.
That way, you can ensure your investment strategy aligns with your financial goals.
6) Not taking advantage of your spouse’s or child’s ISA allowance
You may have made sure you’ve maximised your own ISA allowance but remember if you have a spouse or civil partner they also have a £20,000 allowance.
So, if you’ve used up your allowance in full, transfer any additional assets to your spouse to enable them to take advantage of theirs. There is no tax charge for this kind of transfer. Be aware, however, that the assets will then legally belong to them, so make sure you trust them.
Children also have up to £9,000 in their Junior ISA allowance (JISA). By contributing in full to their JISAs, you will be encouraging them to see the value of long-term, tax-free savings.
As a family of four, you could potentially have a pot of £58,000 (£20,000 x 2 pus £9,000 x2), free from tax on interest, income and capital gains. So, provided you have sufficient funds, it is worth maximising your ISAs.
If you’d like more recommendations about taking full advantage of your ISA allowance, please get in touch.
The value of investments can fall as well as rise and is not guaranteed.
The information contained within this article is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.
The content in this article was correct on 21/10/2024.
You should not rely on this article to make important financial decisions. Teachers Financial Planning offers advice on savings, pensions, investments, mortgages, protection equity release and estate planning for teachers and non-teachers.
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