Firstly, some basics. There are two main types of ISA:
- Cash ISAs
- Stocks and Shares ISAs
At the moment, a UK resident can shelter up to £15,240 in an ISA and pay no income tax or capital gains tax on any income arising or gains made. In addition, any income or gains made do not need to be declared on a tax return. Over a period of years, the amount sheltered from tax can build up into a sizeable sum, particularly where both spouses or both civil partners utilise the allowance.
For added flexibility, you can invest the full amount in any combination between the two types of ISA so, for example, you could have £3,000 in a Cash ISA and £12,240 in the Stocks and Shares part.
ISA eligibility is fairly straightforward:
- For a Cash ISA, you need to be 16 and over
- For the Stocks and Shares ISA, you need to be at least 18
- You need to be UK resident
A Junior ISA can be opened by a parent for a child under 16 and a further £4,080 can be sheltered in a tax free environment. This can also be held in a cash or stocks and shares variant or combination of both. Once the child reaches the age of 16 they can manage the money themselves but cannot access the funds until aged 18. A child aged 16 or 17 can actually subscribe to both a Junior ISA and an "adult" Cash ISA.
ISAs do not have to be funded by "new" money. Existing investments can also present an ISA opportunity as certain types of assets can be transferred to an ISA, turning a taxable investment into a tax free one. For example, existing cash lying in a bank deposit account can become a Cash ISA whilst existing gilts, unit trusts and investment funds can be transferred to a Stocks and Shares ISA. Individual company shares can be transferred into an ISA but only if they were acquired previously through an employee share save scheme.
You can transfer from a Cash based ISA to a Stocks & Share ISA and vice-versa, retaining all the tax free benefits of the ISA holding. The tax efficiency of ISAs has also been extended in recent years as, on the death of a spouse or civil partner, their ISA holding can be transferred to the surviving partner. Previously, the tax free status of that holding would have been lost on death.
For those with a higher risk tolerance, the annual ISA allowance can be invested in an Inheritance Tax (IHT) efficient "AIM IHT ISA". Not only does this type of ISA have the standard tax benefits of a Cash/Shares ISA but it is also IHT efficient. It will be free of IHT on death providing it had been held for at least two years at the point of death. The ISA transfer rules allow existing Cash and Share based ISAs to be transferred to this AIM IHT ISA and this can result in a 40% IHT tax saving for the estate, assuming of course, that the qualifying criteria are met.
If you haven't yet utilised your full annual ISA allowance, now is the time to do so. For financial planning advice to include on setting up or contributing to an ISA, please get in touch.