Individual Savings Accounts, also known as ISAs, are a little gift from the UK government to help your money grow in a tax-friendly way. But the amount you can put in an ISA is limited thanks to your ISA allowance. Here’s how it works.
How do ISA allowances work?
So, what is your ISA allowance? Put simply, it’s how much money you can put in ISAs in a given tax year. As things currently stand, your annual ISA allowance for the 2023/24 tax year is set at £20,000 (although this amount is subject to change each year).
You have until midnight on the 5th April to make the most of this allowance – otherwise you’ll lose it forever as you’re not allowed to carry it over at the end of the tax year.
What happens if you exceed your ISA allowance?
If you’ve accidentally paid too much into your ISA (or ISAs if you have multiple), you won’t get any tax relief on the excess payments you’ve made.
But don’t worry. If you do exceed your ISA allowance, you can contact HMRC to let them know, or if you haven't realised you've done this, they will get in touch with you after the end of the tax year to let you know what you need to do to correct your mistakes.
ISA Historic Allowances
ISAs were introduced back in 1999, and this may come as a surprise to you, but the annual allowance hasn’t always been £20,000. In fact, it used to be a lot less.
For the 1999/00 tax year, the ISA allowance was set at £7,000, but you could only put up to £3,000 in a Cash ISA. Then in 2008/09, the annual allowance increased by £200 (bringing it to £7,200), although it went up by £200 (to £3,600) for Cash ISAs.
But the real push was felt in 2014/15 when the government decided to increase the ISA allowance to £15,000 a year.
The other big boost happened in 2017/18 when the annual allowance rose to £20,000 for the first time, making it possible for savers and investors to considerably increase their contributions. The ISA allowance amount has remained the same ever since, though it could be subject to change again in future.
What are the different types of ISAs?
In total, there are four main types of ISAs for adults: Cash ISAs, Stocks and Shares ISAs, Lifetime ISAs, and Innovative Finances ISAs.
Every tax year, you can pay into one of each type and use your annual allowance as you want to. You can either put the whole amount all in one ISA type or split it between the different types of ISAs – the choice is up to you.
But before you make a decision, it’s important to know how each ISA type works. Let's get into it, shall we?
When it comes to saving money, you can either open a traditional savings account or a Cash ISA.
What’s the different between them, you ask? Well, although they both let you save money and pay you interest, a Cash ISA removes tax from the equation. As the interest you earn with a Cash ISA is tax-free, you get to keep all of your profits.
On the other hand, with a traditional savings account, you’d pay income tax on earnings exceeding £1,000 if you’re a basic rate taxpayer1.
Paying into a Cash ISA is often seen as a safe option as your returns are guaranteed and you have easy access to your money. However, it’s important to see the full picture and consider the impact of inflation on your savings.
Inflation is when, over the years, things get gradually more expensive. If your income doesn’t follow the general rise of prices, your financial ability to buy products and services, or purchasing power, will decrease. And that's the same situation with your savings.
If the interest rate you get from the bank falls below the current rate of inflation, the value of your savings will go down in real terms. And if you were to take your money out after a number of years, you’d quickly realise that you can’t afford to buy as much as you once could.
If your aim is to build an emergency fund, then holding a Cash ISA could help. However, if you’re pursuing long-term growth, you’ll need to find a Cash ISA that beats inflation, and if you can’t, then why not consider other options, like investing in a Stocks and Shares ISA?
Stocks and Shares ISAs
With a Stocks and Shares ISA, also known as an Investment ISA, you get to invest in assets like shares, bonds, property, and commodities. And just like a Cash ISA, you don’t need to pay any tax on capital gains you make or income (interest and dividends) you earn. You can keep everything you earn from your investments, minus any charges and fees.
Paying into a Stocks and Shares ISA does involve some risk as there’s no guaranteed return on your investment, meaning you could get back less than you initially invested. However, since your profits aren’t tied to any fixed interest rate, there’s also a potential opportunity that you could earn higher returns than you can from your cash savings.
And although investing is risky, there are ways to mitigate this risk. For instance, if you want to spread your investment risk and ride out market bumps, it could be a good idea to diversify your portfolio by buying lots of investment types and investing in different regions. With a diversified portfolio, the likelihood of losing everything effectively decreases as poor performing investments could be balanced out by others doing well.
But diversification isn’t the only way to mitigate risk. Studies show that the longer you invest, the more likely you are to make a gain. For instance, people who invested in the FTSE 100 for any 10-year period between 1984 and 2021 have had an 89% of making a positive return – which is quite a high probability2!
How to open a Stocks and Shares ISA
Opening a Stocks and Shares ISA can feel like a daunting task, but it doesn’t have to be. With digital investment platforms, like Wealthify, setting up a Stocks & Shares ISA is easy! All you need to do is choose your investment style and the amount you’d like to invest – you can start with as much or as little as you want. We’ll do the rest for you, from picking and managing your investments to keeping your Plan on track with your risk level and investment goals.
And if you want to use your money to drive positive change in society, we offer Ethical Stocks and Shares ISAs where you get to support companies that are committed to making a positive impact on the environment and society.
Lifetime ISAs are here to help you save towards your first home and/or retirement. Opting for a Lifetime ISA means you can hold cash or investments, or a combination of both, and the choice is completely up to you. And no matter your choice, you won’t pay tax on any profits you make.
But it doesn’t stop there! With a Lifetime ISA, you’ll also receive a 25% bonus on any contribution you make – this is £1 for every £4 you put in, up to a maximum of £1,000 per year.
Lifetime ISAs come with many rules, so before you open one, make sure you’re familiar with these:
- You must be at least 18 but under 40 to start a Lifetime ISA
- The Lifetime ISA limit is set at £4,000 per tax year (subject to change) and it counts towards you annual ISA allowance (£20,000)
- You can contribute to your Lifetime ISA until your 50th birthday, but you must make your first payment before you're 40
- You must be a first time buyer if you intend to buy a house
- The home you want to buy must cost £450,000 or less
- You must keep your Lifetime ISA open for at least 12 months before you can use it towards a deposit for your first house
- The funds in your Lifetime ISA can only be withdrawn to purchase your first home or once you turn 60 (or in in certain circumstances where you are terminally ill)
Innovative Finance ISAs
By opening an Innovative Finance ISA, you’ll become a lender and provide loans to approved individuals and businesses via an online peer-to-peer lending platform. And in return for lending your money, you’ll receive a fixed amount of tax-free interest over a specific period of time.
Innovative Finance ISAs are designed to make the lending/borrowing process more direct, and without a bank sitting between the lender and borrower, there could potentially be greater opportunities and higher returns. But it also comes with greater risk.
With an Innovative Finance ISA, your money isn’t protected by the Financial Services Compensation Scheme, so if borrowers were to default, you wouldn’t be able to make a claim for compensation and you would lose your money. Make sure to gauge your risk appetite before paying into an Innovative Finance ISA.
How to use your ISA allowance
The way you use your ISA allowance is totally up to you. But if you wait until the end of the tax year to pay into your ISA, you could be missing out on potential growth. And although the deadline may seem a long time away, using your annual ISA allowance as early as possible could help you maximise your potential returns.
How, you ask? Well, the earlier you start making contributions into an ISA, the longer your money could have to benefit from the power of 'compounding'. When you save money in a Cash ISA or savings account, you receive interest – and if this is left untouched, these profits could grow over the years and generate further profits – that’s compounding in action.
Similarly, when you invest, you'll have the option to reinvest any potential profits you make and when you do this, these profits could flourish and generate more profits, which, when reinvested, could make even more profits, et cetera. The longer this goes on for, the more potential your money could have to grow even further. However, one important thing to remember is that with investing your capital is at risk, so you could get back less than you put in.
Here’s an example to illustrate how powerful compounding could be over time. Say you invest £7,000 in a Stocks and Shares ISA. After 15 years, you could receive around £11,569. Now add another decade and you could end up with £16,966 – that could give you an extra £5,397 in your pocket4.
And the best thing is that don’t necessarily need to max out your ISA allowance. If you can’t afford to save or invest large lump sums, then that’s absolutely fine. You may still be able to build a decent nest egg for the future by putting small sums aside regularly over the long-term. For instance, by putting just £50 a month in a Stocks and Shares ISA for 20 years, you could potentially end up with £17,2955.
How do withdrawals affect your ISA allowance?
The effect withdrawals will have on your ISA allowance will mainly depend on whether you have a flexible ISA. If your ISA is flexible, you can take money out and your current ISA allowance will vary accordingly.
For instance, if you put half of your £20,000 ISA allowance in, then withdraw £2,000 in the same tax year, your remaining ISA allowance will be £12,000. However, if your ISA isn’t flexible, your ISA allowance will remain the same regardless of how much you’ve taken out. So, if you have £10,000 in an ISA and withdraw £3,000, then your ISA allowance will remain £10,000 despite having £7,000 in the account.
Make sure you check with your provider whether they offer flexible ISAs.
Obviously, withdrawing money from your ISA is a decision only you can take, but as a general rule, dipping into your ISA will slow down any potential growth and you could be paying a lot in fees if your provider charges you for doing so. So, unless you really need the money, consider leaving your ISA alone for a number of years, so your money has a better chance to grow.
Do ISA transfers impact your ISA allowance?
Transferring ISAs that you’ve opened in previous tax years won’t affect your current ISA allowance and you’ll be able to transfer the balance in full or in part.
For example, if you’re transferring £5,000 from an ISA opened 2 years ago and haven’t used this year’s allowance yet, you’d still be able to put up to £20,000 in a new ISA.
However, if you’re looking to transfer your current year’s ISA, it will count towards your ISA allowance. Say, you’ve put £5,000 in a Stocks and Shares ISA and want to transfer it to another provider. You’ll need to transfer the full amount (£5,000) and you’ll have £15,000 from your annual allowance left to use with your new provider.
How to transfer your ISA
With online investment platforms, like Wealthify, transferring your ISA has never been easier!
Tell us how much you’re transferring, how long you’re planning to invest for, and how much risk you’d like to take. We’ll then send you a transfer form to sign and send back to us as soon as possible. After that, our dedicated Customer Care team will sort everything out for you and tell you when it’s done!
For every ISA transfer, please make sure you always use the official transfer form. Once transferred, we’ll look after your ISA and make sure your money is working as hard as you do.
2: Data from Bloomberg
3: This is the projected value for a Confident Plan (Medium Risk Plan) with an Original theme. This is only a forecast and is not a reliable indicator of future performance. If markets perform worse, your return could be £7,652. If markets perform better, your return could be £17,274. Values correct as of 18/05/2023
4: This is the projected value for a Confident Plan (Medium Risk Plan) with an Original theme. This is only a forecast and is not a reliable indicator of future performance. If markets perform worse, your return could be £10,031. If markets perform better, your return could be £30,101. Values correct as of 18/05/2023
5: This is the projected value for a Confident Plan (Medium Risk Plan) with an Original theme. This is only a forecast and is not a reliable indicator of future performance. If markets perform worse, your return could be £13,269. If markets perform better, your return could be £22,731. Values correct as of 18/05/2023
The tax treatment depends on your individual circumstances and may be subject to change in the future.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.