A cash ISA can be a good home for your savings if you pay tax on your savings interest.
That is because interest earned on a cash ISA is paid 100 percent tax-free, whereas any interest that you earn over your Personal Savings Allowance, on the other hand, is taxable at your normal tax rate.
What is a cash ISA?
A cash ISA or an individual savings account is basically an account that pays tax-free interest, as compared to savings accounts on which you may be required pay tax (such as notice savings accounts, easy access versions, and fixed rate bond).
Although in terms of features, there is not much difference that can be noted between savings accounts and cash ISAs, there is a fundamental difference in the amount that you can pay into a cash ISA which is limited to a maximum allowance in any tax year.
What is a cash ISA allowance?
Each tax year, you receive a fresh ISA allowance. In the 2017/18 tax year, you have an ISA allowance of £20,000, which can be maintained in an innovative finance ISA, in a stocks & shares ISA, in cash, or in any combination that you choose. You can also use a maximum of £4,000 of your allowance to invest in a Lifetime ISA to save up towards retirement or for a first home.
Listed below are your options:
- £20,000 entirely invested in a stocks & shares ISA. You don’t have to place any of your ISA allowance in a cash or innovative finance ISA.
- £20,000 entirely invested in a cash ISA. You don’t have to place any of your ISA allowance in a stocks & shares or innovative finance ISA.
- £15,240 entirely invested in an innovative finance ISA. You don’t have to place any of your ISA allowance in a stocks & shares or cash ISA.
- The entire £20,000 allowance divided between the three, however you like.
- £10,000 in a stocks & shares version, £10,000 in a cash ISA.
- £14,000 in a stocks & shares ISA, £6,000 in a cash ISA.
- £6,000 in an innovative finance ISA, £7,000 in a stocks & shares ISA, £7,000 in a cash ISA.
- £16,000 in a cash ISA, £4,000 in a lifetime ISA.
Each UK resident that is over the age of 16 has the same cash ISA allowance. Young adults who are aged 16 and 17 receive an additional Junior ISA limit of £4,128, as well as the adult ISA allowance. However, they cannot invest in an innovative finance ISA or a stocks & shares ISA until they reach the age of 18.
The allowance is an individual limit. An ISA can only be maintained in a single name, and you can only pay into one of each ISA type per tax year. For example a wife and husband receive an ISA allowance each but must hold separate ISA accounts. Joint ISAs are not an option.
If you do not make use of your full ISA allowance by the end of the tax year (5 April), you will lose it – you cannot carry it over.
Making withdrawals from a cash ISA
Your cash ISA allowance is basically the amount of new money that you are permitted to pay into a cash ISA in a given tax year. From April 2016, you can choose to withdraw and replace money from your ISA without affecting your ISA allowance. The restriction applies to ‘new money’ that are added into the account. For example:
- If you fully subscribe the ISA with £20,000 on April 6, you can then withdraw, say, £15,000 at a succeeding date, and replace that £15,000 during the same tax year without breaching your ISA allowance.
However, if you made the same subscription, withdrew the £15,000 and then added a further £17,000 back in instead, this would be a breach on the ISA limit by £2,000 so would not be accepted as part of your tax-free allowance.
Not all ISA providers will be granting this level of flexibility in their ISAs, so if this is likely to be important to you, you will need to verify with them before investing.
Cash ISAs can be transferred
You can transfer a cash ISA whenever you want to. However, a special process is to be followed. Some cash ISAs (particularly those fixed-rate versions) may charge an interest penalty when you transfer out, and if you are transferring ISA money that you have paid in this tax year, the whole lot must be transferred to the new account. Cash ISAs can be transferred to other cash ISAs or to stocks & shares ISAs, or vice versa, however not all providers will support transfers in of previous ISA pots.