Personal Saving Allowance
As at tax year 2021/22 the PSA (Personal savings allowance) is £ 1,000 for basic rate tax payers and £ 500 for higher rate tax year payers. This means, particularly for basic rate tax payers, you will have to have significant savings to generate enough interest to incur taxation on your savings. With the ISA allowance currently at £ 20,000 per tax year, it will take some years to build a cash ISA large enough for tax to be a factor. Hence for short term investors a cash ISA would hold little benefit over a normal savings account. For short term investors the most important factor will therefore be to find the highest interest, whether that is within an ISA wrapper or not.
On the other hand, a cash ISA makes considerably more sense for those with long term investment aims. If you intend to save into your cash ISA for many years and utilise fully your yearly ISA allowance, then you will eventually have build an ISA account large enough to generate interest over the PSA.
Transferring your deceased spouse’s ISA account
A great benefit of an ISA account since 2017, is that the spouse of a deceased ISA account holder, can subscribe the value their deceased’s spouse’s ISA into their own ISA account. This is known as an APS. Even if they do not hold an ISA account the surviving spouse can open one for this specific purpose. Those funds or assets will therefore continue to be protected from income tax and, in the cash of a stocks and shares ISA capital gains tax.
Making withdrawals
Another factor which has made cash and stocks and shares ISA more attractive to investors is that they can be flexible. Hence if you do need, in an emergency, to withdraw funds from your ISA account, then you will be able to replace those funds back into your ISA before the end of the tax year. Please note, not all ISAs are flexible, check with your provider when opening an ISA account.
Investing in stocks and shares
For investors who wish to invest in stocks and shares, a stocks and shares ISA is a must. This applies regardless of your investment strategy. All income and CGT will be safe from tax if invested in an ISA account. Though the annual dividend allowance allows investors to earn £ 2,000 in dividends tax free, it would still make sense to put the first £ 20,000 of your yearly investments into an ISA account, safe in the knowledge you are protected from UK taxation.
Consider fees
One caveat to the above recommendation for stocks and shares investors, is to consider the fees you will be charged by your provider. You should consider the fees you will suffer in the stocks and shares ISA of your choice compared to a general investment account. This is particularly significant if you are planning to invest relatively small amounts of money and you intend those investments to be short term. Bear in mind you can earn £ 2,000 in dividends tax free and the CGT threshold is £ 12,300. Therefore small investors will not likely see much benefit from the tax free wrapper.
Have you bought your first home?
If you have not bought your first home and are under the age of 40, then a lifetime ISA account would be an attractive option for the first £ 4,000 of your yearly investments. Lifetime ISA’s allow you to invest £ 4,000 of your yearly ISA allowance in cash or in stocks and shares. You will then receive a bonus of 25% on your subscriptions. Thus subscribing £ 4,000 every tax year will generate a bonus of £ 1,000 for you to use when buying your first home. A Lifetime ISA is also a consideration for augmenting your retirement savings. Please note though, you can only withdraw your lifetime ISA savings at the age of 60, without paying the withdrawal charge. Also, you will not be able to make further subscriptions after the age of 50.
The future
Whilst the various tax thresholds for income, dividends and CGT make ISA accounts seem less attractive, future changes in the tax thresholds, the ISA allowance and interest rates, may make your investments more susceptible to taxation. In this scenario having build up a large ISA portfolio over many years could reap significant benefits.
Conclusion
For the long term investors and regular savers a cash ISA account is still a good option. It keeps you safe from UK taxation regardless of how long you invest and how much money you build up in your account.
Short term cash investors are better placed to consider the interest on offer as their main criteria.
Stocks and shares investors, in most cases, will be best placed to use the first £ 20,000 of their yearly investments in a stocks and shares ISA.
Finally those people intending to buy their first home (and under 40), would be foolish not to take advantage of the potential lifetime ISA bonus of £ 1,000 per year.