Individual Savings Accounts (ISAs): the facts
The Individual Savings Account (ISA) is a tax exempt savings vehicle for UK resident investors.
- Investors are not taxable on income received from ISA savings and investments, and no tax is payable on capital gains arising.
- ISAs can offer an alternative tax-efficient investment strategy for those individuals who can no longer benefit from tax relief on their pensions savings.
- Investors can subscribe in each tax year to one cash ISA, one stocks and shares ISA, one innovative finance ISA and one lifetime ISA.
- Subscriptions can be transferred freely between cash, stocks and shares, and innovative finance ISAs.
- A child can hold two types of Junior ISA – a stocks and shares JISA and a cash JISA – but no more than one of each type throughout their childhood.
ISAs first became available on 6 April 1999 and Junior ISAs on 1 November 2011.
Investors are not taxable on income received from ISA savings and investments, and no tax is payable on capital gains arising (capital losses are disregarded). Investment returns do not need to be declared in tax returns. Also, ISA income is ignored when calculating entitlement to personal allowances for individuals with adjusted net income exceeding £100,000. See our Personal Allowances article.
The exemption from income tax is contained in Sections 694 to 701 Income Tax (Trading and Other Income) Act 2005, and the exemption from Capital Gains Tax (CGT) is in Section 151 Taxation of Chargeable Gains Act 1992. The detailed rules, however, are to be found within the ISA Regulations 1998 (SI 1998 No 1870) and subsequent amendments.
The relative simplicity and longevity of ISAs means that they are a core product in the UK savings market and, in particular, offer an alternative tax-efficient investment strategy for those individuals who can no longer benefit from tax relief on their pensions savings, having contributed up to their combined annual allowance and carry forward facility.
Budget 2014 announced that from 1 July 2014 ISAs were to be reformed into a simpler product, the New ISA (NISA). All existing ISAs became NISAs and account holders benefitted from new flexibility in relation to their accounts, as well as an increased overall subscription limit. NISA savings can be held in cash or stocks and shares in any combination that the saver wishes.
An investor can subscribe to a Cash NISA and a Stocks & Shares NISA in the same year splitting the overall allowance between the two.
The NISA was not a separate scheme. Instead, there remained two types (Cash and Stocks & Shares) and, from 1 July 2014, they operate under amended ISA Regulations.
Now that the NISA changes have bedded in, the remainder of this article will revert to the term ISA (indeed HMRC use the term ISA).
From 6 April 2016, investors can subscribe in each tax year to:
- One cash ISA
- One stocks and shares ISA, and
- One innovative finance ISA, and
- One lifetime ISA
It is not possible to subscribe to two (or more) cash ISAs, two (or more) stocks and shares ISAs, two (or more) innovative finance ISAs or two (or more) lifetime ISAs in the same tax year.
In the March 2015 budget, the government introduced the concept of a flexible ISA.
ISA manager bulletin 65, published in July 2015, stated that the change would become law in autumn 2015 following discussions with ISA managers and others. Subsequently, HMRC published documentation giving rise to a period of technical consultation, which closed on 8 November 2015. This documentation made it clear that the measure will have effect from 6 April 2016.
On 15 January 2016, HMRC published Flexible ISA guidance notes. In particular, it is noteworthy that this new flexibility extends to cash holdings in non-cash ISAs - a fact which seems to be at odds with the original budget announcement.
Points worthy of note:
- A flexible ISA is an ISA whose terms and conditions allow the investor to replace cash withdrawn without the replacement counting towards his/her annual subscription limit.
- Flexibility is optional for ISA managers, and is not available for Junior ISAs.
- To be eligible to subscribe to an ISA, an investor must be UK resident (unless the overseas Crown employee rules apply). In the case of a flexible ISA replacement subscription, the investor can, however, be non-UK resident.
- In each tax year, investors may subscribe to one cash ISA and one stocks and shares ISA. With this in mind, flexible ISA replacement subscriptions do not count as subscriptions for the purpose of the 'one ISA of each type per tax year' rule.
- Flexibility can be offered in respect of cash only. It can be offered for cash ISAs and also in respect of any cash held in a stocks and shares or an Innovative Finance ISA (including from the sale of investments).
The Lifetime ISA (LISA)
The lifetime ISA was introduced from 6 April 2017 to help people, aged between 18 and 39 (at 6/04/17), to save in a flexible manner for the long term and ensure they do not have to choose between saving for retirement and saving for their first home. The contribution limit is £4,000 per tax year and remains within the overall limit of £20,000. The Government will add a bonus of 25% to these contributions each year and from 2018/19 this is paid monthly instead of annually.
Money can be withdrawn from the LISA penalty free at any time (after 12 months from the start date) to purchase a first home worth up to £450,000.
Thereafter, money can be withdrawn penalty free at age 60.
Those who are terminally ill with a life expectancy of less than 12 months will be able to withdraw the funds including the Government bonus penalty free.
If funds are accessed early for any other reason there is a penalty of 25%.
Help to Buy ISA
This allows those aged 16 and over to save up to £200 per month, on top of an initial investment of up to £1,000, towards a deposit on their first property purchase.
If the investor has savings in the help to buy ISA of £12,000, the government will boost those savings by 25% to £15,000. The maximum bonus is £3,000 per person. The bonus will be available on home purchases of up to £450,000 in London and up to £250,000 outside London. Accounts are limited to one per person rather than one per home - so those buying together can both receive a bonus.
Note that a help to buy ISA is effectively a cash ISA, meaning that savers cannot take out a separate cash ISA in the same tax year. An individual could, however, subscribe to a stocks and shares ISA and, following recent reforms, invest fully in cash if the provider allows this.
A help to buy ISA was open for new savers until 30 November 2019, and open to new contributions until 2029. Subscriptions made to a help to buy ISA will count against a saver’s annual subscription limit for the relevant year.
Innovative Finance ISA
The qualifying investments for an innovative finance ISA are:
- Peer-to-peer loans
Who can subscribe and subscription limits
An individual investor must be aged 16 or over if subscribing to a cash ISA, or 18 or over if subscribing to a stocks and shares or innovative finance ISA. Where investments held outside an ISA are sold and the proceeds subscribed to an ISA then this constitutes a disposal for capital gains tax purposes.
Strictly, all ISA applications must be made by the investor (see later for JISAs). An ISA manager may however accept an application by someone legally appointed or authorised to act on behalf of the investor if the investor is not able to complete the application form by reason of:
- mental disorder or incapacity, or
- physical disability, illness or old age.
Shares can be directly transferred into an ISA if they have been acquired by the investor from a Schedule 3 SAYE option scheme or a Schedule 2 Share Incentive Plan. Shares cannot be directly transferred into an ISA in any other circumstances. The market value of the shares at the date of transfer counts as the amount subscribed to the ISA. The total of the share value and any other cash subscribed must not exceed the subscription limits.
Investors must transfer shares from a Schedule 3 SAYE option scheme into an ISA within 90 days of the exercise of option date.
Investors must transfer shares from a Schedule 2 Share Incentive Plan into an ISA within 90 days after the shares ceased to be subject to the plan.
Parents who give money to their children (aged under 18) to invest in their cash ISA need to be aware that if gifts from a parent produce more than £100 gross income in a tax year, the whole of the income from the gifts is normally taxed as that of the parent (S629 ITTOIA 2005). The child’s gross income includes income from cash ISAs, but excludes income from JISAs.
An investor must be resident in the UK (not the Channel islands or the Isle of Man). A Crown employee serving overseas and their spouse/civil partner may also subscribe. For those who fail to meet the residence criteria then existing ISAs can be retained, but not subscribed to.
If the individual is resident he/she can apply for an ISA and will be able to subscribe to that ISA for the whole of the tax year. If the individual is not resident in a later tax year, he/she can no longer subscribe to the ISA until UK residence is resumed. If the investor has a continuous application in place and has been non resident, there will always be a gap year as the period of non-residence must last for a whole tax year and no subscriptions will be possible for that gap year. If the investor becomes UK resident again at a later date, a fresh ISA application will be required.
Cash subscriptions from the investor’s employer may be accepted where the employer confirms that the payment will be treated as a relevant payment to an employee for the purposes of the PAYE Regulations and a payment of earnings for the purposes of Class 1 NIC.
From July 1 2014, it became possible to save the annual allowance in cash, stocks and shares or any combination of the two. It is possible to have a single account for both cash and stocks and shares investments, but savers may prefer to hold separate accounts for cash and stocks and shares investments.
The following do not count as subscriptions for the purposes of the 'one ISA of each type per tax year' rule:
- Additional permitted subscriptions (see below)
- Flexible ISA replacement subscriptions (see above)
Subscription limits are as follows:
JISA Limits are as follows:
Those aged between 16 and 18, can hold a Cash account but cannot open a Stocks and Shares account.
From 6 April 2015 additional permitted subscriptions, on top of the annual subscription limit are available to the surviving spouse of a deceased ISA holder.
Additional permitted subscriptions are available in respect of deaths on or after 3 December 2014. The deceased and the surviving spouse must have been living together at the date of death. That is, not separated under a court order, under a deed of separation, or in circumstances where the separation was likely to be permanent.
Additional permitted subscriptions:
- are limited to the value of the deceased's ISA at their date of death if the investor died on or before 5 April 2018
- can be either the value of the deceased’s ISA at their date of death or the point the ISA ceased to be a continuing account of a deceased investor if the investor died on or after 6 April 2018
- can be made with the manager who held the deceased's ISA or another manager who will accept
- must be made within specific time limits
- can be made in cash or inherited non-cash ISA assets
- are available whether or not the surviving spouse inherited the deceased's ISA assets
- can be made by non-residents
- cannot be made to a Junior ISA
- can be made to a cash, stocks and shares, or an innovative finance ISA
- can also be made to a Lifetime ISA if the investor is resident in the UK, but will count towards the Lifetime ISA payment limit but not the annual overall ISA additional permitted subscription limit
- count as previous year subscriptions for all other ISA purpose.
An ISA opened solely to receive the additional permitted subscriptions will not cause the saver to breach the 'one ISA of each type per tax year' rule.
Qualifying investments for stocks and shares ISA
Stocks and shares ISAs can include:
- shares and corporate bonds (with at least five years to redemption when first held in the ISA ) issued by companies officially listed on a recognised stock exchange anywhere in the world, or are admitted to trading on a recognised stock exchange in the EEA.
- Gilts issued by the UK government, similar securities issued by governments of other countries in the European Economic Area and 'strips' of all these securities.
- units or shares in authorised funds (unit trusts or Open Ended Investment Companies (OEICs)).
- units or shares in non-UCITS (Undertakings of Collective Investment in Transferable Securities) retail schemes authorised for sale to retail investors in the UK.
- shares and securities in investment trusts.
- units or shares in UCITS funds based elsewhere in the European Union (these are similar to authorised unit trusts and OEICs).
- any shares which have been transferred from an HMRC approved SAYE share option scheme or Share Incentive Plan.
- stakeholder medium-term products.
- Life insurance policies on the life of the ISA investor (unit linked or with profits policies)
Life insurance policies must meet a number of conditions to qualify and only those specially designed for ISAs can be included. The policies may be the ISA manager’s own policies, or the manager may offer policies from different insurers.
Company shares traded on any market of a recognised stock exchange in the EEA became eligible for inclusion within a stocks and shares ISA from 5 August 2013. Company shares which became newly eligible for ISA inclusion as a result of this change remain eligible for the Enterprise Investment Scheme (EIS), the Venture Capital Trust (VCT) scheme, and Inheritance Tax Business Property Relief (BPR). If an investor sells an investment that currently qualifies for EIS, VCT, or BPR and his/her ISA manager uses the proceeds to purchase a replacement holding of the same shares for investment in an ISA, the effect would be that:
- for EIS, the sale of the original holding will be a disposal for the purpose of the provisions for withdrawal of EIS Income Tax reliefs. The new holding will qualify for EIS relief only if it is new shares in a qualifying company.
- for VCT, the sale of the original holding will be a disposal for the purpose of the provisions for the recovery of VCT tax reliefs. The new holding will qualify only for dividend relief and Capital Gains Tax exemptions under the VCT rules.
- for BPR, there would be two ownership periods, one for the original holding and one for the 'new' holding in the ISA wrapper. Provided the combined ownership period was more than two years, BPR would be available on the replacement holding.
Cash may be held in an 'adult' stocks and shares ISA if the provider allows. Prior to 1 July 2014, cash could only be held for the purpose of investment in qualifying investments. Cash includes cash subscriptions, interest and dividends, and proceeds from disposals of investments that have not yet been reinvested. An investor can now therefore hold cash tax-free within a Stocks and Shares ISA if desired and if the provider allows.
From 1 July 2014, an investor can also acquire the following investments to hold in a Stocks and Shares ISA:
- Certain Core Capital Deferred Shares issued by a building society;
- Certain securities, such as retail bonds, which have less than 5 years to run to maturity at the time they are first held in the account
Qualifying investments for cash ISA
Qualifying investments for cash ISAs include:
- Cash deposited in bank and building society accounts
- National Savings and Investments products that are specially designed for ISAs (but not other National Savings and Investments products such as the Investment Account, Savings Certificates or Pensioners' Guaranteed Income Bonds)
- Alternative Finance arrangements, such as Sharia-compliant products
From 6 April 2016 subscriptions can be transferred freely between cash, stocks and shares, and innovative finance ISAs.
If the investor wishes to transfer savings relating to any current year's payments, then these must be transferred as a whole.
However, any savings relating to payments in earlier years can be transferred in whole or in part. Not all ISA providers will allow part transfers, so the investor must check this with the provider.
Closing an ISA
The ISA manager may close a particular ISA where the terms and conditions allow. For example, where the balance falls below a particular level.
Under ISA regulations, investments must remain in the beneficial ownership of the investor. However, under the Insolvency Act, a bankrupt’s estate vests in a trustee meaning that ISA investments cease to be in the beneficial ownership of the investor. Accordingly, an ISA manager notified of the bankruptcy of an investor must close it with effect from the date on which the trustee's appointment takes effect (or, in the case of the Official Receiver, the date on which he becomes trustee).
An ISA ceases on the death of the investor, however, under ISA regulations the tax advantages are extended until the earlier of the following -
- The completion of the administration of the estate,
- The day falling on the third anniversary of the death, or
- The closure of the account within the meaning of regulation 4B(3)(a).
so that personal representatives and beneficiaries or legatees do not face income tax or capital gains tax on investments retained in an ISA during the administration of a deceased saver's estate.
As mentioned above, the instrument also modifies the additional permitted subscription (APS) available to spouses and civil partners of deceased ISA holders. The value of the APS is now set at the higher of the value of ISA investments held on the date of death, or at the point when the account ceases to be a continuing deceased’s account.
Where there is a life insurance policy within the ISA, it will pay out on death. Any gain treated as arising as a result of death is exempt from tax.
Where an ISA is found to be invalid (for example, the subscription is invalid) then in certain circumstances the ISA can continue after corrective action, or ‘repair’. Invalid accounts that cannot be repaired must be voided meaning that all income in respect of the invalid subscription is to be taxed and all the invalid subscription and the (taxed) income has to be removed from the ISA. Valid subscriptions from previous (and possibly later) years are unaffected. If the ISA contains an insurance policy, and any of the excess subscription to be removed is assigned to that policy, it must be removed in full. An insurance policy cannot be repaired: it must either all stay in the ISA or all be removed.
Junior ISA (JISA)
A child can hold two types of JISA:
- a stocks and shares JISA, and
- a cash JISA.
Unlike 'adult' ISAs where the investor can open and subscribe to new ISAs in each tax year, a child can only hold up to two JISAs (no more than one of each type) throughout their childhood (although between ages 16 and 18 they can hold one of each type of JISA plus an ‘adult’ cash ISA). However, no child is required to hold either type of account. They may have no JISA at all, or only one type of account.
A child cannot hold an innovative finance ISA.
A JISA application can only be made by a person aged 16 or over. Where the child is aged 16 or over, either the child or a person with parental responsibility for the child can apply to open the account. Where the child is under 16 only a person with parental responsibility for the child can apply to open the JISA.
When application is made the child must be under age 18, and not an eligible child for Child Trust Fund purposes.
The account must be held in the name of the child but any person can subscribe to it. Simplified due diligence will apply to the opening of a JISA so full Money Laundering checks are not required on the child or the applicant for the JISA. The person subscribing need not be resident in the UK, nor do they have to be related to the child. It must be made clear to the person subscribing that they are making a gift to the child which cannot be repaid if at a later date the subscriber changes their mind.
The only amounts that can be withdrawn prior to the child's 18th birthday are to meet certain provider management charges and other specific expenses, or where the child is terminally ill. Should the child die before attaining 18 the JISA will close and the investments will become part of the child’s estate. In all circumstances other than death or terminal illness of an account holder, a JISA must run until the child’s 18th birthday.
As with adult ISAs, accounts can be transferred between account managers.
The types of investments that can be held in these accounts broadly mirror the ‘adult’ ISA rules.
Once the child turns 18, any savings in the JISA that are not immediately withdrawn will stay within a tax-free wrapper albeit that the rules specific to JISA will fall away. The ISA manager may continue with the same account number or allocate a new one depending on what suits its systems and processes.
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