If you are considering an ISA investment then it is essential that you fully understand the key ISA advantages and disadvantages before you act.
Would you buy a car without knowing its cost, fuel type, performance specifications, number of doors, colour, etc etc?
Of course not.
Don’t just make a random investment choice – make an informed decision.
In this case, make sure that you know the pros and cons of ISAs before you invest.
1. What are the Key ISA Advantages and Disadvantages?
We’ll take a look at ISA advantages and disadvantages in the sections immediately below as these are the aspects that most people are primarily interested in.
We’ll then go on to provide some further useful information regarding ISAs to further add to your overall knowledge in this area.
2. ISA Advantages
Here is a list of the factors that may encourage you to make an ISA investment:
- Tax-free status
Any interest, income, or capital gains made within an ISA are completely free from tax. And this tax-free status rolls on from one tax year to the next until the ISA account is closed. There is no tax charge on funds withdrawn from an ISA.
ISAs are very easy to transfer from one provider to another. You can also transfer funds from a Cash ISA into a Stocks and Shares ISA.
- No wrapper charges
Strictly speaking, ISAs themselves aren’t investments. They are an investment wrapper – they provide a tax-free wrapper around the investments held within them. And there is usually no charge for this wrapper.
- No upper limit on age
Unlike SIPPs, there is no upper age restriction for individuals investing in ISAs.
- Wide choice of investments
ISAs offer a very wide range of investment options. The more cautious investor may be attracted to Cash ISAs (although see below for Cash ISAs – are they worth it?). And the more adventurous investor may be attracted to stocks and shares, funds, bonds, gilts, and Exchange Traded Funds (ETFs).
- ISA inheritance
It is possible to inherit the ISA savings of a spouse or civil partner on their death. This is facilitated by the use of an Additional Permitted Subscription Allowance (APS). Any ISA funds that are transferred as an APS retain their ISA status and do not impact the recipient’s contribution limit.
3. ISA Disadvantages
And a list of the factors that may discourage you from making an ISA investment:
- Contribution caps
There are relatively low limits on how much an individual may invest in ISA each tax year. At the time of writing the limit is £20,000.
- Impact of withdrawals
Money that is withdrawn cannot be replaced in an ISA without impacting the contribution limit. For example, if you had £50,000 in an ISA and withdrew £10,000 you would not be able to reintroduce those funds and also pay the £20,000 maximum amount – you would be restricted to a total of £20,000 (Although see below for Flexible ISAs).
- No joint accounts
As the name suggests, an Individual Savings Account is for individuals. It is not possible to have joint account ISAs, even for spouses and civil partners.
- No carry-forward of allowances
The annual ISA allowance is of the ‘use it or lose it’ variety. There is no scope for carrying forward any unused allowance to a later tax year. So, if you only invest £10,000 in ISAs this year your ISA allowance next year will still be £20,000 – it won’t be uplifted to £30,000 to take account of the unused amount.
- No tax relief on contributions
ISAs and SIPPs are opposites when it comes to tax treatment. A SIPP benefits from tax relief on contributions but an ISA does not. An ISA benefits from tax-free withdrawals but withdrawals from a SIPP are taxable (apart from the 25% tax-free element).
- Inheritance tax
In most cases, any pensions that are held can be passed to beneficiaries free of Inheritance Tax. The same is not true of ISAs – they will form part of the deceased’s taxable estate.
- No relief for capital losses
Not having to pay Capital Gains Tax on any gains is great but what if you make some losses? Outside of an ISA you can offset those losses against non-ISA capital gains and even carry-forward unused losses – you can’t do that with capital losses within an ISA.
4. ISA Advantages and Disadvantages – Summary
A quick summary of the pros and cons in table form.
|Tax-free status||Contribution caps|
|Portable||Impact of withdrawals|
|No wrapper charges||No joint accounts|
|No upper limit on age||No carry-forward of allowances|
|Wide choice of investments||No tax relief on contributions|
|ISA inheritance||Inheritance tax|
|No relief for capital losses|
5. Cash ISAs – are they worth it?
Despite the apparent advantages of a Cash ISA the case for having one is becoming weaker and weaker.
Let’s consider why that may be the case:
- The Personal Savings Allowance (PSA)
The PSA was introduced in 2016 and it allows individuals to earn a certain amount of interest tax-free each year. Basic Rate (20%) taxpayers can earn up to £1,000 interest tax-free each year and Higher Rate (40%) taxpayers can earn £500. Additional Rate (45%) taxpayers do not receive a PSA.
The interest rates on Cash ISAs are pretty low at the moment – many at 1% or lower. With that rate, you’d need £100,000 in funds to earn £1,000 in interest. So, the majority of people wouldn’t be paying tax on their interest receipts anyway – and would be better off looking at other non-ISA savings accounts which are paying higher rates of interest.
Inflation is currently running at over 9%! So, what’s happening to the value of the funds in your Cash ISA? That’s right, in real terms, they are shrinking – FAST!
If you are saving for the longer term (typically at least 5 years) then you may wish to consider investing your money rather than saving it as asset-based investments are likely to outperform any type of Cash ISA.
6. Further Information on ISAs
6.1 ISA Legislation
The legislation governing Individual Savings Accounts (ISAs) is contained within The Individual Savings Account Regulations 1998.
However, unless you have a raging case of insomnia, I wouldn’t waste any time reading it! Far better to read the plain English summaries in a blog like this one.
6.2 Types of ISA
There are 4 types of ISA:
- Cash ISA
- Stocks and Shares ISA
- Innovative Finance ISA
- Lifetime ISA
6.3 How ISAs work
The key feature of ISAs is their tax treatment. You do not pay tax on:
- Interest on cash in an ISA
- Income (such as dividends) or capital gains from investments in an ISA
If you complete a Self Assessment Tax Return you do not need to declare any interest, income, or capital gains arising from your ISA(s).
6.4 Who can have an ISA?
ISAs are available to individuals who are UK residents and meet the age criteria:
- 16 or over for a Cash ISA
- 18 or over for a Stocks and Shares or Innovative Finance ISA
- 18 or over and under 40 for a Lifetime ISA
It is not permitted to hold an ISA with or on behalf of somebody else. So, no joint accounts for ISAs.
Note that despite the above age restrictions it is possible for parents or guardians to open a Junior ISA for their children – the money in these ISAs belongs to the child.
Junior ISAs may be of either the Cash type or the Stocks and Shares type. The child can manage the ISA account once they turn 16 and is permitted to withdraw the money once they turn 18.
6.5 ISA Contributions
There are restrictions on the number of funds that can be invested into an ISA in any one tax year (tax years run from 6 April in one year to 5 April in the following year).
At the time of writing the contribution limit is £20,000. This may be put into a single ISA or split between a number of types.
However, the limit for a Junior ISA is £9,000 and for a Lifetime ISA is £4,000.
Example of permitted ISA contributions:
£10,000 – Cash ISA
£5,000 – Stocks and Shares ISA
£1,000 – Innovative Finance ISA
£4,000 – Lifetime ISA.
How long does an ISA last?
ISAs continue to run, and retain their tax-free status, from one tax year to the next until such time as the account holder requests that the account be closed.
What is an Innovative Finance ISA?
An Innovative Finance ISA is a type of Individual Savings Account where the permitted investments include:
* Peer-to-peer loans (loans made by individuals to other individuals or businesses)
* Crowdfunding debentures (individuals investing in a business by buying its debt)
What is a Lifetime ISA?
Lifetime ISAs are special types of Individual Savings Accounts designed to be held for the longer term, either for retirement savings or to use towards the purchase of an individual’s first home (less than £450,000 and bought with a mortgage).
The key attraction is a government bonus of 25% of the money that you put in, up to a maximum of £1,000 per tax year.
You must be a UK resident aged between 18 and 40 to open a Lifetime ISA (although you can continue to pay into one until you are 50). The contribution limit is £4,000 per tax year.
The accounts face an exit charge of 25% of any withdrawal amount unless funds are applied for buying a first home or the individual is aged 60 or over.
What is a Flexible ISA?
The introduction of ISA Flexibility in April 2016 brought major changes to the ways that ISAs could be used. In particular, all Flexible ISAs allow you to withdraw money from your ISA and subsequently replace those funds without any impact on the ISA contribution limits (currently £20,000 per tax year).
Can I Withdraw Cash from my ISA?
Cash can be taken from an ISA at any time without losing the associated tax benefits (although there may be rules and charges imposed by the ISA provider).
Note that for ISAs other than Flexible ISAs you will not be able to reintroduce the funds into the ISA without it impacting the annual contribution limit.
Now that you understand the key ISA advantages and disadvantages you are in a much better position to be able to make an informed investment decision.
In the meantime, please take a look at some of the other posts on the site. Remember, knowledge is power (or, in this case, a Happy Retirement!).