An introduction to ISAs with Claro

This week, we've partnered with financial wellbeing platform Claro, for a run down on everything ISA.

What’s it all about?

Individual Savings Accounts (ISAs) are financial products that help you save or invest your money.

Why should you care?

You don’t have to pay income tax or capital gains tax on the returns you get from an ISA. You also don’t pay tax on the money you withdraw from the scheme (but when you withdraw money, this is counted towards your ISA allowance).

There are different types of ISA depending on your financial goals and you’re allowed to invest up to £20,000 a year (for the tax year 2021/2022) across all of them.

What will you learn?

In this pack, you’ll learn about the different types of ISA, how they work, and what to consider if you want to get in on the action.

What are ISAs?

Individual Savings Accounts (ISAs) are financial products that help you save or invest your money. They’re only available if you’re a UK resident.

ISAs are a ‘tax wrapper’ because you don’t have to pay income tax and capital gains tax on returns or withdrawals.

ISAs have a yearly allowance which can vary every year. For the 2020/2021 tax year, the yearly allowance is £20,000.

There are four main types of ISA which you can choose between depending on your financial goals:

1. Cash ISAs
2. Stocks and shares ISAs,
3. Lifetime ISAs,
4. Innovative finance ISAs (IFISAs)

You can also set up and contribute to Junior ISAs for your kids.

How do ISAs work?

ISAs have a yearly allowance which can vary every year. For the 2020/2021 tax year, the yearly allowance is £20,000. You can spread your £20,000 across the different types of ISA however you like. You just need to make sure you only have one of each type of ISA at a time. For example, if you already have a stocks and shares ISA you can’t open a second one, but you can open a cash ISA.

Bear in mind that the Lifetime ISA has a maximum allowance of £4,000 a year.

What to consider when choosing between types of ISAs

Choosing which type of ISA is right for you will depend on your financial goals and what type of investor you are. Here’s a rundown of the different types of ISA and what to consider when choosing one.

Cash ISAs

Cash ISAs are savings accounts that pay tax-free interest. They’re not an investment.

Cash ISAs are available to anyone in the UK who’s 16 or over. They offer a low-risk way to save for short-term goals. Typically they do not offer great rates, and if the interest rate is lower than the rate of inflation, you may well be losing money in real terms. This is because if your money doesn’t grow as fast as prices do, you’ll be able to buy less with it.

There are a few different varieties of cash ISA:

Easy-access cash ISAs – you can take out your money when you want, without penalty.

Fixed-rate cash ISAs – if you access your money before the end of a set period, you’ll lose some or all of the interest.

Flexible cash ISAs – you can take money out and return it in the same tax year (by 5th April), without losing your current year’s ISA allowance.

Non-flexible cash ISAs – different rules apply to the level of flexibility and penalty fees associated if you want to access your money early.

Generally, you’ll find that the longer your money has to stay in the cash ISA or ‘locked in’, the better the rate of interest.

Cash ISAs are protected up to £85,000 under the Financial Services Compensation Scheme.

Stocks and shares ISAs

Want to use your ISA for investing? Then stocks and shares ISAs are for you. You can invest in:

Funds – a pool of investment types such as stocks and bonds.

Individual stocks and shares – ownership of a small part of companies.

Bonds – IOUs to a company or a government.

Unlike cash ISAs, you usually have to pay fees with stocks and shares ISAs. These could include platform charges, fund management charges, fees on the type of investments you hold, or fees to transfer your funds to another ISA.

Since economic conditions affect stocks and shares ISAs, you should consider investing for a minimum of 3 years. You should also think about drip-feeding your stocks and shares ISA contributions. Both strategies allow you to ride out the ups and downs of the financial market and the economy.

Historically, stocks and shares have outperformed cash savings accounts. But there’s no guarantee they’ll do so in the future. Remember, when investing, your capital is at risk. Investments can go down as well as up, so be prepared for the fact that you could lose money.

Lifetime ISAs

Want to get money from the government and save up for the future? Then a Lifetime ISA is for you.

If you are under 40, you can set one up and contribute up to £4,000 per year and get a government bonus of 25% (up to £1,000) each financial year until you are 50.

You can set up a lifetime ISA as a cash ISA or a stocks and shares ISAs.

You can use your lifetime ISA for two things. To buy your first home, or towards your future retirement savings once you hit 60 years of age. If you take your money out for any other reason, the government will take their bonus back plus the growth on the bonus.

Innovative finance ISAs

The innovative finance ISA (IFISA) lets you use your ISA allowance to invest in peer-to-peer lending or crowding, or lend directly to a business or consumer. There are specific organisations that specialise in peer-to-peer lending and offer this type of ISA.

IFISAs are riskier compared to cash ISAs or stocks and shares ISAs. Since you are lending money, there’s a chance that the borrower will not repay. You can mitigate the risk by spreading cash across multiple loans, or provider-backed safeguard funds.

Junior ISAs

The last type of ISA is the junior ISA. I you set one up for your kids, and family and friends can contribute up to £9,000 to the account on behalf of the child in the 2020-21 tax year. You do not lose any of your own ISA allowance if you contribute to a junior ISA.

You can open junior ISAs as cash ISAs or stocks and shares ISAs.

Junior ISAs are available to any child under 18 living in the UK. The account is in their name, but they cannot access the account until the age of 18.

Other things to consider when looking at different types of ISAs

If you intend to dip into your ISAs, something to consider is whether or not they are flexible. With flexible ISAs you can take cash out and then pay it back in the same tax year without losing your allowance. For example, if you saved the full £20,000 but withdrew £2000, you could pay it back in again later that tax year with a flexible ISA. With a non-flexible ISA, you couldn’t pay the money back in again, as it would take you over your allowance. This flexibility is not available for Junior ISAs or the Lifetime ISAs.

You can also move your ISA from one provider to another, or from one type to another. There may be transfer fees, so check.

Ethical considerations

With ethical investing, many ISA providers will offer ethical and socially responsible funds. Typically, you won’t be able to pick specific companies to invest in, but you do get to satisfy any ethical investing concerns you have. You should be warned, these funds often come with slightly higher fees.

You should try to use as much of your ISA allowance as you can before the end of the financial year since you cannot carry it over.

Where to get ISAs

You can get ISAs from lots of places, including banks, online brokers, platforms, fund manager groups, fund supermarkets or a financial adviser.

Depending on the product and provider, you can get your ISA through a bank branch, online, via an app, by phone or by post.

Key takeaways

That’s a wrap. Here are the key takeaways from this pack.

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- Individual Savings Accounts (ISAs) are financial products that help you save or invest your money.

- ISAs are a ‘tax wrapper’ because you don’t have to pay income tax and capital gains tax on returns or withdrawals.

- For the 2020/2021 tax year, the ISA yearly allowance is £20,000. You can spread your £20,000 across the different types of ISA however you like.

- You have to pay fees when you invest in a fund. Those fees are based on how the fund is set up, managed and administered.

- There are ethical and socially responsible ISAs where the portfolio is pre-selected for you.

- Consider an ISA if you want to save up for things that are important to you in the short, medium and long term.

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