If you are a saver, then tax on your investments can eat into any gains you make. That's why it's so important to consider an Individual Savings Account (ISA), one of the most tax-efficient forms of saving.
An ISA is a tax wrapper, in that it ‘wraps up' your money so that no income tax or capital gains tax is charged on any increase in the value of your savings. There are hundreds of different ISAs to choose from, all falling into one of two categories: cash ISAs or stocks & shares ISAs. There is an annual limit to how much you can put into an ISA, which may change from year to year.
A cash ISA is a relatively secure way of saving, and will accumulate interest each year (some ISAs much more than others, so you need to shop around). If you can make full use of your new allowance every year, your savings can really start to add up. It’s a good idea to keep an eye on your old ISAs too, as interest rates may be reduced from their original levels. In this case, you may be better off moving that cash somewhere else (such as into a better ISA).
Stocks and shares ISA
Your investment may grow more in a stocks & shares ISA, but there is a larger risk involved than with a cash ISA. The value of your investment can go down as well as up, so there is a chance you could lose some or all of your investment. These ISAs are generally better for longer-term investments, the idea being that you can ride out any short-term dips in value in the hope of better growth over time.
Innovative Finance ISA
This lets you loan your money out through peer-to-peer (P2P) lending and pay no tax on the interest. You can open only one such ISA per year, but you can wrap up loans from more than one P2P lending platform in a single ISA. Interest is higher than with a cash ISA, but so is the risk - if enough borrowers default, you could lose your interest or even the capital sum.
This is designed to help you save up for a first home, with a government top-up added. Find out more about them here.
Introduced from April 2017, these will allow you to save up for a first home, for retirement or both, with a government top-up added. Find out more about them here.
Your ISA allowance
The annual investment limit for all your ISAs is £20,000 for the 2016-2017 tax year. You can invest up to this sum in any combination of cash, stocks and shares and peer-to-peer loans. Remember the allowance renews every financial year, so if April is approaching and you have some spare cash, always see if you have some ISA allowance to use up.
Inheriting an ISA
Both the money held in an ISA and its tax free advantages can be inherited by a spouse or civil partner when the original holder dies. The person inheriting the ISA is allowed to use the full tax-free allowance that was available to their spouse or civil partner, in addition to their own ISA allowance.
If you are looking to set up an ISA, it is useful to consult a financial adviser to get a clearer picture of your options. An adviser can help you find the best deals, work out the most suitable combination of cash and stocks and shares, and ensure that your tax-free savings are aligned to your life goals.
Some questions to ask your adviser:
• Are there any charges involved, and what are they for?
• Am I better off investing this money in an ISA, a pension or both?
• Is this the best way for me to be tax-efficient with my money?
• Which is better for me at the moment - cash or stocks and shares, or a blend of both?