Guide to Investment ISAs
From your high street bank to ads online, you’ve probably seen references to a financial product called an ISA (or Individual Savings Account).
An ISA isn’t your typical savings account. Introduced by the UK Government in 1999, an ISA is a tool to encourage more people to actively save their money by offering significant tax benefits in return.
Today, there are six different ISAs available to residents of the UK. The stocks and shares ISA (sometimes called the Investment ISA) is an increasingly popular product because it allows you to not only save money in a ‘tax-free wrapper,’ but it’s also a straightforward introduction to market investments. Stocks and shares ISAs allow you to invest money to seek a higher return than a savings account, and you’ll pay no tax on your earnings, up to the threshold.
These products aren’t just available from financial planners and large investment banks. You can find them in many places, including increasingly from online platform providers. It’s now possible to set up an account and start investing tax-free without ever booking an appointment.
Does this sound like the financial product you’ve been waiting for? We put together a complete guide to the stocks and shares ISA.
A stocks and shares ISA is an investment account that grants you access to several different investment options, which include shares, funds, trusts, and bonds. You can also keep a cash balance within a stocks and shares ISA, which won’t be invested but will instead earn interest.
When you choose an ISA, then you choose a tax efficient investment, which allows you to earn money through your investments without paying income tax or capital gains.
When you invest in a stocks and shares ISA, you have the option of buying individual shares. The availability and range of shares depends on your account provider.
A share is a unit of ownership in an asset or a public company. When you own a share, you receive a distribution of any profit equal to the amount of shares you own. These are called dividends, and most companies pay out dividends twice a year.
You can use shares to generate annual income over a long period of time. Companies offering significant dividends pay what are called income stocks.
In many cases, you will invest in shares through mutual funds, which are available through most stocks and shares ISA providers.
What Are Stocks?
Stocks and shares are largely the same type of investment in that they are both equity investments.
Technically, a share represents a unit of stock.
What is a Fund?
A fund is a collection of money used for a specific purpose. In general, it can be used to set aside money, but it’s also a form of investment.
In the investment world, a fund is run by individual or institutional investors who pool their money in different funds to earn money.
The most common fund found in stocks and shares ISAs is a mutual fund, which gathers money from many different investors and then invests it in a diverse asset portfolio. Each mutual fund receives oversight and management from a professional.
Some stocks and shares ISAs also provide access to exchange-traded funds (ETFs). ETFs are similar to mutual funds, but the investment manager trades them on public exchanges.
Technically speaking, government bonds are also funds. These bonds offer a low-risk investment. The providers that typically offer access to bonds tend to be those that offer a ‘fix-it-and-forget-it’ style of investment ISA, which caters to investors who aren’t looking to actively trade.
What Are the Other Types of ISAs?
A stocks and shares ISA is one of six available ISA products. These include:
- Cash ISA
- Innovative Finance ISA (IFISA)
- Junior ISA
- Lifetime ISA (LISA)
- Help to Buy ISA
Out of these, the cash ISA and LISA are the most popular products both among providers and investors. Although they are popular alternatives to a stocks and shares ISA, there is a big difference: neither the cash ISA or the LISA allow you to invest in the financial markets. Instead, they have their own benefits.
What is a Cash ISA?
A cash ISA is a savings account that offers the same tax-free benefits found in stocks and shares ISA. In 2018, cash ISA products reached a six-year high thanks in part to new products from challenger banks
There is no trading involved in a cash ISA. Instead, they are similar to high-yield savings accounts like those offered by banks on the high street. Typically, these products offer higher interest rates than a high street bank, but they may be more restrictive than a stocks and shares ISA. For example, Virgin Money’s Limited Access Cash ISA offers a high interest rate, but you won’t be able to withdraw money whenever you want.
Cash ISAs are low-risk because there’s no investment involved. You’ll earn according to the product you choose and the interest rate offered. You should be able to calculate exactly how your account will grow, which is ideal for those looking for stability as well as a small return on their investment.
What is a Lifetime ISA?
Lifetime ISAs (or LISAs) are a new type of savings account designed to help savers prepare for large financial milestones, namely saving for a mortgage deposit or for retirement.
LISAs are much more restrictive than either stocks and shares ISAs or cash ISAs, but they come with added perks.
The government also provides LISA investors with a bonus of 25% of what they pay into the account each tax year to encourage and reward savings.
You can only open a Lifetime ISA if you fall between ages 18 and 39. It also allows you to save only £4,000 each tax year, and you can only contribute until your 50th birthday. If you meet the threshold each year, then the government tops up your account by £1,000 (25% of £4,000) each year. You don’t have to pay income tax on money earned (i.e., the government bonus) in this account.
What is an Innovative Finance ISA?
An innovative finance ISA (IFISA) is another type of investment ISA, but it is much less commonly found compared to a stocks and shares ISA. Rather than investing in the financial markets, the IFISA is a peer-to-peer (P2P) lending tool.
If you earn interest on your loan, then you will not pay tax on it.
Even though the IFISA doesn’t involve investment in the market, it does still come with risks. If a borrower defaults on their loan, then you risk losing your money. It’s important to participate in schemes covered by the Financial Services Compensation Scheme (FSCS) as well as stick to P2P platforms with investor protections.
What is a Junior ISA?
A Junior ISA is effectively a savings account that serves as a tax-wrapper. Unlike the lifetime ISA, the junior programs exist for parents to use to save for their children’s future. Junior ISAs exist both as cash ISAs and stocks and shares ISA.
Some of the ISA rules change for this program. For the 2019/2020 tax year, the annual subscription limit is £4,368, and it can be split into a cash and stocks and shares account. However, you can’t have more than two active accounts for one child at any one time.
While some parents choose to use it as a way to maximize their tax strategy, it’s important to remember that ultimately the money belongs to the child. The named child becomes aware of the account at age 16: the notification happens automatically. The child named on the account can access the money when they turn 18, and not before. Once they turn 18, the parent loses control of the investment.
What is a Help to Buy ISA?
A Help to Buy ISA is the UK Government’s scheme for first-time home buyers. To open an account, you must never have owned a property in the UK or elsewhere in the world.
You’ll still see guides to Help to Buy products around the internet. However, the government replaced the Help to Buy ISA with the Lifetime ISA at the end of 2019
If you already have a Help to Buy ISA account, then you can continue saving into it..
Stocks and shares ISAs cater to people who want to save a lump sum over a long period, at least five to ten years. One common misconception is that you can’t draw down a stocks and shares ISA without facing a penalty. You can not only withdraw but also change provider whenever you please. However, you lose the tax benefits on the money withdrawn if you choose to reinvest it.
If you’re thinking about investing as a form of income generation or to save for retirement, then a stocks and shares ISA is one of the helpful tools available to you.
Everyone who intends to save strategically should include a stocks and shares ISA (or another appropriate ISA product) in their portfolio. It’s an ideal starting point because
Can I Use an ISA if I Don’t Know Much About Investing?
You don’t need to be a competent investor to use a stocks and shares ISA. The purpose of a stocks and shares ISA is to provide a tool for anyone who has an interest in saving to enjoy the benefits of investing without having studied finance at university.
If you have cash savings, then there is no reason not to use a stocks and shares ISA, particularly given the tax benefits. Though, it is important to remember that any investment in the financial markets comes with risk: cash savings is inherently low ris.
What’s more, the range of ISA providers means there is a stocks and shares ISA account suited to people across the financial literacy spectrum. You can find an account that ranges from being completely hands-off to one that allows you to play around with every last detail of your portfolio. Because you can transfer your stocks and shares ISA without losing your tax benefits, you can also move between providers as your goals change.
Robo-advisors are a boon to new account holders. These represent the hands-off type of provider. When you use a robo-advisor, you only need to choose your preferred level of risk and share your financial goals. The platform’s proprietary algorithm makes all further decisions on your behalf. Your only requirement is to log-in to check on your accounts when required and to update your details.
Can I Move My Existing Investments to an ISA?
So, you already have investments that fall outside of the tax wrapper? You can move them into your tax-free ISA.
The product is called a Bed and ISA, and it allows you to sell up to £20,000 of shares and funds in a traditional investment account (or another taxable account) and move them into a tax-free stocks and shares ISA.
Unfortunately, it’s not as straightforward as it sounds. When you sell outside of an ISA, you can trigger a capital gain or loss, which means you will pay tax (or not ) on those funds because they’re outside the tax wrapper. Additionally, you will likely spend on a dealing charge and stamp duty.
Each stocks and shares provider takes a different approach to the Bed and ISA. You’re more likely to find them among traditional providers, like Vanguard and IG.
Should I Transfer My Pension to an ISA?
Given the new rules making pensions more flexible and the increased limits for ISAs, some may wonder if it’s a good idea to transfer pension funds into a stocks and shares ISA account.
You can’t transfer your pension to an ISA, at least not directly. To transfer your pension to an ISA, you would need to withdraw the funds and do so manually.
If you already have a pension, it usually makes more sense to continue paying into it or, if you’re unhappy, consider transferring your pension to a new provider.
Is there any scenario where you could benefit from withdrawing your pension and investing in an ISA? Usually, you should only do this if it benefits your tax bill. It’s helpful to talk to your tax accountant about your liabilities and then make the appropriate decision from there.
Remember that ISAs and pensions face different tax rules. Pensions can be passed on tax-free to a surviving spouse, children, or even grandchildren, and you typically won’t pay inheritance tax on the remaining funds when you die. The flexibility makes pensions a very valuable investment tool.
In 2015, the government increased the ISA investment limit to £20,000 per year. You can invest that £20,000 in one account or spread it out across multiple ISAs.
While many people tend to put their money in and leave it, some providers do allow you to open a ‘flexible’ stocks and shares ISA. If you open this account, you can withdraw from your ISA and reinvest in the same tax year. For example, if you invest £20,000 and then withdraw £5,000, you can still invest another £5,000 before you reach your threshold. These accounts are rare because there’s little demand for them.
Remember that stocks and shares ISA are helpful long-term planning investment tools. They’re not well-suited for short-term investments.
In theory, you can invest as much as you want in a stocks and shares ISA. However, the tax benefits only apply to the first £20,000 per year.
You can open one stocks and shares ISA account each tax year. You can also open a cash or lifetime ISA each year.
However, you can open a new account in subsequent tax years.
If you’re a diligent saver, you may find that you have multiple stocks and shares ISA accounts with different providers.
Keep in mind that your investment limit remains set at £20,000 each year no matter how many products you have.
Do You Get a Tax Refund when You Invest in an ISA?
No, you don’t receive a refund or deduction by investing in an ISA.
Instead, any money you earn from your investment is tax-free (up to the £20,000 annual threshold).
A stocks and shares ISA is an investment account. Any investment account comes with risk: you could earn nothing or even lose money on your investment. There are no guarantees of any return.
With that said, you typically earn money from a stocks and shares ISA in one of two ways: income or capital growth. Your preference dictates your investment strategy.
You’ll generate income through dividends (from shares) and/or interest (from bonds). The income generated likely won’t be enough to pay for day-to-day costs, but it typically works as a way to supplement your pension.
If you’re using the ISA to save for a big purchase, then you’ll pick a lump sum to receive at the end of your investment period.
The growth of your account depends largely on your risk strategy. A higher risk strategy gives you the opportunity to earn far more, but it also comes with more significant risk. If you’re saving over a long-term period, then you’re more likely to benefit from a strategy that involves more risk because you have the opportunity to lose and recoup your losses over a longer period of time.
If you need the money over the next one to five years, then you’re more likely to benefit from a lower risk strategy because you have less time to recover. That being said, if you’re hoping to save for a deposit on a house or achieve a similar goal, then a Lifetime ISA might be a preferable choice, as you’ll earn a 25% bonus as well as interest without worrying about swings in the market.
Current interest rates are low, which is favourable for borrowers but not so much for savers. In February 2020, the Bank of England base rate was 0.75%. An increase looks unlikely, which means rates across the board will be low, particularly for new savers.
There are pros and cons of choosing a cash ISA over a stocks and shares ISA. Cash ISAs are relatively stable, protected by insurance, and don’t require regular maintenance. You can set up a monthly transfer and leave the account to rest. It will earn on its own.
If you put £10,000 in a cash ISA account with a 1% interest rate, your initial investment will grow to £11,046 after ten years of annual compounded interest. You’ll earn a tax-free sum of £1,046.22 over a decade.
Annual returns from the stock market tend to be significantly higher than the 1%. If you invest £10,000 in a stocks and shares ISA in a lump sum and leave it over ten years with a 5% return, you’ll have £16,288.95 at the end of your investment period. It’s a difference of over £5,000, which is still tax free.
Of course, a 5% return isn’t guaranteed. One year, you may earn a 7% return and the next it could drop to 3%. The market goes up and down and trends towards long-term investments. However, you can limit your losses by using a diverse portfolio and leaving some money in cash. These are options available with the typical stocks and shares ISA.
What if a Provider or Fund Manager Collapses?
There is no insurance to protect your investment from market movements. If the market takes a nosedive and impacts your investments, then you will make a loss (if only temporarily).
However, if your ISA provider or fund manager dissolves and you are owed money, you may be able to claim compensation to the tune of the size of your investment on the day your provider went bust.
The compensation is only available if the manager participates in the Financial Services Compensation Scheme (FSCS). It will cover you for £50,000 per person per institution.
You are also covered if your investment dissipates due to negligence or mis-selling.
What Does an Investment ISA Cost?
Unlike cash ISAs and savings accounts, an investment account, including stocks and shares ISAs, come with fees. Noting these fees is important because they will eat into your returns.
Fees can make significant difference in your earnings whether you invest £10 a month or reach the full £20,000 threshold each year.
These fees typically include:
- Management fees
- Transaction fees
- Annual account fees
Each fee impacts investors differently, depending on the investments you choose, the amount you hold, and how often you interact with your account. It’s important to price compare between accounts to avoid being overcharged and watching any returns melt away into your provider’s pockets.
It’s important to understand what holding a stocks and shares ISA will cost you because it is the one thing that will hurt your profits (bar changes in the market).
There are several great calculators out there that allow you to make the calculation for each product according to your approximate investment size and the fees charged.
The Financial Times provides a helpful calculator that also visualises the data in graph form, which makes it easy to digest.
Should You Choose an Online ISA Platform?
Challenger banks and traditional investment firms are increasingly offering online-only stocks and shares ISA products. In fact, many high street banks are more likely to only offer the simplest ISAs available, usually cash ISAs and junior cash ISAs.
Choosing an online only ISA platform is a great way to save on fees, largely because you won’t have access to personalised investment advice or asset management.
Because the government sets the rules on ISAs, you’ll need to look at the platforms themselves to choose the best product.
What Types of Platforms Are Available?
UK stocks and shares ISA platforms typically fall into one of three categories:
- Do-it-yourself options
- Help along the way options
- Completely managed options
The do-it-yourself provider is for anyone who already has trading experience. These platforms give you total control over your portfolio, but you’ll need to do all the research yourself and you’ll need to keep track of it on your own.
Don’t confuse the DIY-style for a barebones platform. A good provider will provide research insights, charts, and most of the other tools you need to build and manage your own portfolio.
Help Along the Way
A significant amount of ISA providers are willing to provide investors with help. What does this look like? In most cases, you make your own investment decisions, but there’s a helping hand to narrow down your options or make recommendations. However, you’re not forced into a particular program.
The great thing about these middle-of-the-road platforms is that you’re both better equipped to create a portfolio that meets your goals but you also have room to grow your knowledge to take more control of your portfolio. You do the research, but the provider completes the analysis and creates the funds for you.
Some of these platforms will also offer accounts that cater to frequent traders, so you can level-up without necessarily feeling the need to transfer out.
The fully-managed platforms require only one thing: your bank account details. When you use this type of platform, you won’t make any decisions at all nor will you need to do any research. When you sign up, the platform passes you through a filter based on a risk-profiling survey. You’ll then be shuttled into the appropriate option, and the platform takes care of the rest.
In most cases, a fully-managed provider will offer exchange traded-funds (ETFs) only.
The lack of choice isn’t inherently bad. On the contrary, research shows that ETFs offer reliable performance for long-term investments, which is the best thing you can ask for if you don’t want control of your investments
A few of these platforms include:
It’s worth noting that while something that’s fully managed sounds like it would cost more, these products can often be cheaper than the help-along-the-way options listed above.
Why? Because unlike those options, the fully-managed products tend to rely only on software. There’s very little interaction between the investor and the provider. Plus, ETFs are much cheaper to run than mutual funds or other types of financial instruments. The very nature of these platforms trends towards cost-cutting — at least to a point. They do tend to be more expensive for mature accounts.
Can You Transfer an Investment ISA?
Yes, you can transfer an ISA between providers as long as you’re transferring the same type of ISA. In other words, you can transfer your stocks and shares ISA to another provider’s product. There’s no financial regulation preventing you from doing so.
Keep in mind that every provider is obligated to allow you to transfer out, but not all providers will accept your transfer in.
How to Transfer an ISA to a New Provider
You are entitled to transfer your stocks and shares to a new provider whenever you see fit. There are no tax implications for doing so, and there is no minimum term associated with each account.
In an ideal world, you choose a provider who makes transfers easy. If so, all you need to do is set up a new stocks and shares ISA (remember, you can only set up one new account each year) and inform your new provider that you wish to transfer in an existing ISA and provide your existing account details.
Your new provider will then contact your existing ISA provider to initiate and complete the transaction.
The big question is the cost. Some ISA providers unfortunately still charge exit fees if you leave their service. These fees are deeply unpopular, but they still exist.
However, some providers do offer bonuses to cover exit fees for new account holders. Even still, it is worth calculating the cost of their ISA product to make sure that you won’t end up paying more in management fees later, even if you do recoup some costs now.
When is it Time to Transfer an Investment ISA?
Transferring your stocks and shares ISA is common because both your needs and the markets change over time. Many people consider transferring their products to a new provider when they:
- Find a new provider who offers lower fees and commissions
- Decide to keep all their investment products with one provider
- Become unhappy with their provider’s customer service
- Want to find a more hands-on approach
- Wish to transfer ISA types (you can transfer a stocks and shares ISA to a cash ISA as of July 2014)
If you’re someone who wants to transfer your ISA type, it’s important to complete a transfer. Don’t withdraw your money and then re-invest it. Once you withdraw, you risk losing your tax-free benefits, particularly if you have a mature account.
You may withdraw money from your stocks and shares ISA at any point. Providers dictate this process for you.
Withdrawals can usually happen online or through your app (if available).
Keep in mind that a stocks and shares ISA means your money is in the market, so withdrawals aren’t instant. If you are trying to withdraw after selling investments, know that you can’t access the proceeds until after the settlement date noted on your contract.
Most providers will transfer the money within a few business days. If you need the cash immediately, your provider may have a unique option (such as a CHAPS payment), but you can expect to pay a surcharge and you will likely need to request it manually via the customer service team.
What Should You Drawdown First: Pension or ISA?
Are you ready to access your retirement income? You may wonder what investment you should drawdown first, particularly after the 2015 pension drawdown changes that made the process more flexible.
The answer differs for each person, and your age is a significant factor.
For anyone under 55, it is usually simpler to withdraw from your ISA (whether stocks and shares or any other type) than your pension. ISAs have no access restrictions, and there are no penalties for withdrawing unless you intend to reinvest.
Additionally, if you intend to access more than 25% of your pension and you’re still of working age, then you could trigger a limit on what you’re allowed to contribute from that point on (at least in Defined Contribution pension post).
Choosing to withdraw from your ISA first also tends to make sense when you are older than retirement age. The proceeds from an ISA aren’t subject to income tax. However, if you don’t spend your ISA and it moves into your estate after you die, they are subject to inheritance tax. The same is not true of pensions (if you pass before age 75). If your pension is passed on, then your beneficiary will only pay income tax on it as they withdraw, which is far less than inheritance tax.
If you’re concerned about the future tax implications for your estate, it’s helpful to talk to an estate planner and tax accountant, who can help make sure you spend in such a way that you minimise your estate’s tax liability.
A stocks and shares ISA is a type of investment ISA that allows you to potentially earn a greater return on your savings, at least compared to a cash ISA or a traditional savings account. Not only will you benefit from returns often greater than interest rates, but you can invest your first £20,000 each year without worrying about taxes.
Ultimately, every stocks and shares ISA provider is different. There’s no one-size-fits-all solution. So, it’s important to do plenty of research before investing. Even still, keep in mind that you are free to change providers as it suits: so there’s no reason to feel trapped.
Even though each product and provider caters to different investors, it’s worth noting that ISAs and stocks and shares ISASs, in particular, are helpful tools that all UK residents should consider using before opening taxable accounts. Although an ISA isn’t the totality of your retirement planning or savings plan, it is a very helpful start.
Peter Field CFA
Peter uses his many years of experience to oversee the reviews and guides published on InvestingReviews.co.uk
When not at his desk, Peter is training for his next triathlon and trying to be a great dad and husband.