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What is an Isa? Individual savings accounts explained

Published

3 days ago

September 16, 2024

What is an Isa? Individual savings accounts explained

Use our savings tax calculator to see how much you’d pay if your cash was held in a savings account, so you can decide whether it’s worth switching to a cash Isa instead.

You’ll have to consider the trade-off between how much tax you could save with an Isa, compared to the extra interest you could earn with a savings account.

For cash Isas, it’s important to shop around for the best rate – but you’ll need to consider when and how often you need to access your money, or how long you can afford to lock it away for. You should also look carefully at any transfer fees, in case you see a different Isa with a better rate and want to switch.

Claire Trott, of St James’s Place, said: “Cash Isas allow you to earn tax-free interest on your money and are conveniently flexible, offering simple access to your cash if you hit an unexpected expense.

“While it’s key to put as much into your Isas as you feel comfortable with on a regular basis, you want to be sure that any Isas you do have are getting good rates and earning their keep. Ensuring you monitor your mix of cash and stocks and shares Isas over the whole tax year can help make the most of your money.”

If you do opt for a stocks and shares Isa, it’s more complex. Experts say you should be willing and able to play the long game.

Mr Hollands said: “Investing should be considered as a long-term game of at least five years, as the value of investments can fluctuate up and down. In a nutshell, investing and holding on for the long term is more important than trying to guess whether markets are about to go up or down in the short term.

“For those who are worried about the short-term ups and downs of financial markets, one way to overcome this is to invest on a regular, monthly basis via direct debit. Over a year, this will smooth out some of the short-term gyrations in the markets, and it is also a great discipline that keeps you steadily investing when the headlines are both cheerful or gloomy.”

Ms Trott added: “If you have a stocks and shares Isa, it can make sense to drip feed payments into your account over the year, rather than making one big payment just before tax year-end. That way, you flatten out the natural rises and falls in the stock market and share values, rather than making a big payment on a day when the market happens to be lower.”

What happens if you exceed the £20,000 allowance?

If you pay more than £20,000 into Isas in a tax year, HMRC will usually detect the error, as Isa providers are required to submit figures each year. HMRC should let you know what to do next.

Your Isa provider may be instructed to remove the excess money that was deposited, and you could be taxed on any interest or growth it earned. You won’t lose the original money you invested.

If you realise you’ve overpaid, there are steps you can take. This starts with calling HMRC on 0300 200 3312.

Can I carry over an allowance from a previous year?

Unfortunately not – Isa allowances reset every April 6. However, you don’t need to spread the payments evenly over each year. For example, you could pay in £20,000 on April 5 and another £20,000 on April 7, as these are different tax years.

What if I take money out mid-year – can I put more in without exceeding the allowance?

Generally, no. Any money you put into most Isas will count towards your annual allowance.

However, some Isas are “flexible”, which means you can take cash out and put it back in without reducing your annual allowance, provided it’s within the same tax year.

For example, if you put £10,000 into a flexible Isa, then withdrew £3,000, you can still put another £13,000 into the same Isa that tax year. However, you could only deposit £10,000 into other types of Isa.

Money held in Isas will generally form part of your estate, meaning it may be liable for inheritance tax.

If your spouse or civil partner dies, there’s a tax-saving mechanism that means you can inherit their tax-free savings – but you’ll need to follow the rules, and they can be tricky.

How do I transfer an Isa?

You should use the Isa transfer system offered by your provider. Anyone who tries to bypass the official Isa transfer procedure could come unstuck because as soon as your money leaves its protective Isa “wrapper” it becomes taxable. This would be the case if, for example, you transferred the balance of your cash Isa to your current account before later sending it to a different cash Isa.

Ms Trott also said that consolidating Isas into one plan can make it easier to keep track of your money, but there are things to watch out for.

She said: “If you transfer as cash, you’ll be out of the market until the transfer is complete. You won’t lose out if the market falls, but your money won’t be subject to any income or growth if the market rises in this period. If you transfer a fixed rate cash Isa before the end of the term, you may have to pay a fee.

“If you’re transferring funds from a stocks and shares Isa, you’ll remain invested until the transfer. You’ll be unable to switch or sell these funds while the market falls or rises during this time.”

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