ISAs are a great way to shelter interest and dividend income from your savings and investments – particularly if you’ve used up your pension allowances or need access to the money before age 55.
Anyone aged 16 and over can now shelter up to £20,000 from tax in an ISA in 2018/19. Although you must be over age 18 to invest in a stocks and shares ISA or an innovative finance ISA.
Make the most of your ISA allowance
The ISA allowance is ‘use-it-or lose-it’, which means the current year’s allowance expires on 5 April. However, the government has announced that the allowance will remain the same in 2019/20.
Savers and investors looking to shelter more than £20,000 can therefore use both the allowance for 2018/19 and for 2019/20 to move up to £40,000 into ISAs as early as 6 April 2019. For example, a couple who haven’t used their ISA allowances for 2018/19, could potentially shelter £80,000 between them in ISAs by 6 April 2019.
For cash savers, interest rates are still very low, but marginally better compared with this time last year. The best instant access ISAs pay around 1.45% 1.
The best two-year fixed rate cash ISAs pay around 1.86% 2, while those who are prepared to lock their money away for five years can get around 2.27% 2.
Understanding the personal savings allowance
When it comes to cash savings, basic rate and higher rate taxpayers also benefit from the personal savings allowance.
This allows up to £1,000 of interest a year for basic rate taxpayers or £500 a year interest for higher rate taxpayers, to be received tax-free from normal (non-ISA) cash savings accounts. Nil-rate taxpayers can also receive interest up to the level of their unused part of their personal allowance (£11,850 in 2018/19) without paying tax on interest. The best instant access accounts pay around 1.5% 3. The best two-year fixed rate cash bond pays around 2.35% 4, while the best 5-year bond pays around 2.7% 4.
The biggest takeaway from this is that normal savings accounts generally pay higher rates of interest than cash ISAs. If the interest from cash savings is within your personal income tax allowance or the personal savings allowance, it may be better to hold your cash savings in a normal savings account. This will leave your ISA allowance free for stocks and shares.
If you’re prepared to take a bit more risk, then a stocks and shares ISA is an option. These ISAs usually invest in shares or bonds and can potentially deliver much better returns than cash over the medium to long-term.
You should only consider a stocks and shares ISA if you’re prepared to invest over a longer period. And bear in mind that higher returns than cash are not guaranteed, because no one knows how investment markets might perform in the future.