Individual Savings Account
An Individual Savings Account (ISA; pronounced /ˈaɪsə/) is a financial product available to residents in the United Kingdom. It is designed for the purpose of investment and savings with a favourable tax status. Money is contributed from after tax income and not subjected to income tax or capital gains tax within a holding or upon withdrawal. Cash and a broad range of investments can be held and there is no restriction on when or how much money can be withdrawn. Funds can not be used as security for a loan. It is not a pension product but can be a useful complement to a pension for retirement income, particularly when it is desirable to draw down capital at a faster rate than permitted in a pension.
Introduction of ISAs
ISAs were introduced on 6 April 1999, replacing the earlier Personal Equity Plans (PEPs) and Tax-Exempt Special Savings Accounts (TESSAs). ISAs were explicitly designed to appeal to a broader range of the population than these earlier products, which were sometimes claimed to be exclusively for the benefit of the middle classes. Other channels for tax-privileged savings exist that also pre-date ISAs, notably the National Savings and Investments, which is a state owned bank offering a range of non-ISA tax free accounts (in addition to its own ISAs.)
With a few exceptions, such as from an employee share ownership plan, all investor contributions must be in cash. ISAs are available to UK residents aged over 16, but individuals between 16 and 18 are only permitted to use the cash component.
There are two broad types of ISA, cash or stocks and shares.
A cash deposit that is similar to any other ordinary savings account, apart from the tax-free status. A cash ISA can also hold a qualifying investment that fails the five percent test for holding within a stocks and shares ISA but this capability is rarely, if ever, made available.
The money is invested in 'qualifying investments'. Except for cash there must be a credible possibility of losing at least five percent of the investment, otherwise the investment must be held in a cash ISA instead. Qualifying investments are:
- cash "awaiting investment". There is no specific time limit on how long cash can be held. The test is whether the ISA manager believes the money is being held for future investment, instead of as a way to pay only the 20% charge on cash interest instead of a higher rate of income tax, which would circumvent the cash ISA contribution limit.
- UCITS authorised funds like unit trusts and OEICs.
- investment trusts that satisfy various possible conditions
- stock market company shares listed on one of the many recognised stock exchanges. Merely being traded is insufficient, it must be a full listing, and this excludes AIM' PLUS-quoted and PLUS-traded market segments, but PLUS itself is acceptable; shares in unquoted companies; warrants; futures and options.
- public debt securities such as government, corporate bonds, debentures and Eurobonds which have at least five years of their term remaining. Conditional redemption, such as that based on possible future market performance, is acceptable, as is the borrowing company or government redeeming the security early or exercising of options if there are defaults, insolvency risks or covenant breaches.
- various non-UCITS retail investments
- depository interests such as CREST Depository Interests (CDIs) or American Depository Receipts (ADRs) provided there is an underlying listing on a recognised stock exchange or other qualification for the underlying investment to be held.
As a consequence, the risk profile of the ISA may be anything from low to high depending on the mixture of investments used.
Junior ISAs are being introduced from 1 November 2011 with an initial subscription limit of £3,600. At age 18 the JISA converts to an adult ISA. Like adult ISAs, JISAs are available in both cash and stocks and shares types. Money cannot be withdrawn until age 18 unless a terminal illness claim is agreed or following closure of the account after the death of the child. A child can open their own account from age 16, otherwise a person with parental responsibility can do it. They are available to those who are:
- under age 18 and
- were born on or after 3 Jan 2011 or do not have a CTF account, and
- are resident and ordinarily resident in the UK, or are a UK Crown servant, married to or in a civil partnership with a Crown servant, or a dependent of a Crown servant.
Unlike an adult ISA a child can only hold a total of one cash ISA and one stocks and shares ISA, including for all money from past years, but transfers of these two accounts can be carried out between providers as for adult accounts. Up to the full JISA limit can be used for any combination of cash and stocks and shares ISA subscriptions. An additional adult cash ISA account can be held between 16 and 18. In the year in which a child becomes 18 the full adult and child ISA limits can both be used. Unlike adult ISAs a JISA allows transfers from the S&S form to the cash form.
Each child ISA account has a single registered contact, a person with parental responsibility. From age 16 a child can register to be their own contact and this registration cannot normally be reversed. Except in that case and adoptive parents registering, the previous registered contact will be contacted to obtain their consent to a change of contact.
There are restrictions on investing in ISAs in each tax year (6 April to the following 5 April) which affect the type of ISA that may be opened and the cumulative amount of investment during the course of that year. The key restrictions are:
- No more than the annual amount limit can be paid in and the amount that can be in cash is restricted in an adult ISA. Any amount not used for cash can be used in a stocks and shares ISA.
- Newly subscribed (paid in) money in the current tax year can only be held in up to one cash ISA and up to one stocks and shares ISA.
- Provided the annual contribution limits are not exceeded HMRC can be expected to forgive one transgression using too many accounts and merely post a letter reminding about the rules after the annual returns from ISA providers reveal the problem. This should not be relied upon, as it is at HMRC's discretion.
These restrictions only apply to money paid in during the current tax year. For adult ISAs an unlimited number of accounts can hold money from past years and it can be freely moved between providers using ISA transfer requests.
Tax year Cash limit Stocks & shares limit Total subscription limit Junior ISA limit 1999/2000 to
£3,000 £4,000 £7,000 not available 1999/2000 to
£3,000 £7,000 £7,000 not available 2008/2009
£3,600 £7,200 £7,200 not available 2010/2011 £5,100 £10,200 £10,200 not available 2011/2012 £5,340 £10,680 £10,680 £3,600 2012/2013 £5,640 £11,280 £11,280 £3.600
In the March 2010 budget the Chancellor of the Exchequer Alistair Darling announced that in future years the limits would rise annually with inflation, rounded to the nearest £120, to ease the mathematics for those using monthly payment schemes. From 2013-14 the inflation index used is changing from RPI to CPI.
Initially there was a distinction between a 'mini' ISA, which could hold cash OR stocks, versus a 'maxi' ISA which could hold cash AND stocks. Any UK resident individual of at least eighteen years of age could invest in one 'maxi' ISA, with both components provided by a single financial institution. Alternatively, a person could invest in two 'mini' ISAs, one for each component. The two mini ISAs could be with two different providers if the investor wished. TOISAs and the full transfer of ISAs created in previous years to another provider had no bearing on these restrictions. From tax year 2008/2009 the distinction between a mini and maxi ISA was abolished.
It is possible to transfer ISAs from one manager to another; however, there are several points to be aware of.
- It is possible to transfer from a Cash ISA to a Stocks and Shares ISA, but not the other way around in an adult ISA. This was introduced in 2008/2009. A JISA can go in both directions.
- Whether the original contributions were made to a Maxi or Mini has no effect on transfer.
- The transfer must be done between the managers. If a saver transfers the money manually, it will be treated as a withdrawal and they cannot invest this in an ISA if their subscription limit has already been reached.
- As an aid to those who transfer by withdrawing money paid in during the tax year and redepositing by mistake, HMRC allows a single cash self-transfer per year. All money must be removed from the source account and the account closed. HMRC will then consider it an innocent self-transfer and forgive the error, treating it as if the money had never been paid in. The maximum that can be redeposited is still subject to the annual limit, so if past years' money is withdrawn it may not be possible to redeposit it all.
- When transferring it is still necessary to comply with the rule that you can have only one cash ISA and one S&S ISA open at the same time with money paid in from the current tax year. Transfer of cash ISA money paid in during the current year must be all of the money if it is to another cash ISA. If the transfer is from cash to S&S the transfer can be partial but must be to either the first S&S ISA of the year or to the one that current year money has already been paid in to. After the transfer to S&S the money counts against the S&S limit, not the cash limit.
- You can transfer from a cash ISA to a S&S ISA then withdraw the money from the S&S ISA and redeposit some or all the money into another cash ISA. This allows you to circumvent "new money only" restrictions imposed by some cash ISAs that will not accept transfers in.
- Cash within a TOISA is treated as a cash component, and can be transferred to a "normal" cash ISA.
Fund Supermarkets and Self Select ISA providers
There is no legislative difference between a Fund Supermarket and a self select ISA provider. These are merely marketing terms used by stocks and shares ISA providers to distinguish the type of business that they tend to seek. Firms favouring collective investment business will often call themselves fund supermarkets while firms that have traditionally been involved in share dealing will often call themselves self select ISA providers. A firm can freely offer all types of permitted investment, regardless of its name, and many do. Others choose to specialise in only funds.
Except for fund houses themselves it's normal for providers to offer the ability to hold funds from many different houses. This makes it easy to hold funds from many fund houses and avoids the limitation to one fund house per year that the single S&S manager for new money each year rule would otherwise create.
Instead of charging the investor, the S&S providers are often paid by the fund managers out of their usual charges, though some may have both explicit dealing charges and collect the commission while others may make charges and refund all commission.
The ISA cash component normally has no disclosed charges, taking them into account in the interest rate offered, although some providers charge a fee for transferring to another provider.
The built-in annual "re-registering" of an ISA may attract a fee which may be automatically extracted from an account, though this is normally done only by firms specialising in share deals, not those using funds or both funds and shares.
Stocks and shares ISA fund supermarkets often reduce some or all of the initial and annual charges made by fund houses to below the level paid when purchasing direct from the fund provider, often to zero initial charge. Some providers levy dealing charges even for fund transactions, typically firms desiring direct share investments more than fund investments. Dealing charges for shares are normal even from providers that do not charge for fund transactions. Firms that primarily focus on fund transactions tend to have higher share dealing charges than providers specialising in share transactions.
Interest on deposits in a cash ISA is not taxed, whether it is an instant access or term deposit.
Interest on cash in a S&S ISA is subject to a 20% charge. Dividends are not subject to additional tax, interest on bonds is not taxed and all capital gains are not taxed, nor may capital losses be claimed to offset other gains.
There is no need to report interest or other income, capital gains or trades to HMRC and it is not considered to be taxable income. This is a considerable paperwork reduction for active traders or those who may otherwise be required to report their trades because they have total sales value exceeding four times the annual CGT allowance, which outside a tax wrapper would require that all trades be reported even if there is no CGT to pay.
Since the income is not taxable it also does not count for age-related personal income tax allowance reduction, making ISAs useful for those aged 65 or over with incomes approaching £22,900, who could otherwise lose personal allowance.
From 6 April 1999, advance corporation tax (ACT), payable by companies when they paid dividends, was abolished. Previously, under the imputation system of taxation, recipients of a dividend were entitled to a tax credit which reflected the payment of ACT by companies. This tax credit reduced the amount of tax that was payable by the recipient of a dividend and, where the recipient's tax liability was less than the tax credit, the excess could be reclaimed (particularly by non-taxpayers, such as charities, pension funds and PEPs).
From April 1999, companies have not been required to pay ACT, and dividends are accompanied by a 'notional' 10% tax credit. The ability of certain non-taxpayers to claim a repayment of this 'notional' tax credit was phased out from 6 April 1999 to 5 April 2004, effectively removing some of the originally tax-free status (although higher-rate taxpayers have no further liability which they would do on dividends held outside an ISA). The result is that a fund primarily used for income rather than capital growth is far less tax efficient (especially for non higher-rate taxpayers) when placed in an equity fund, whereas a fund based exclusively on other asset classes (such as bonds) continues to be tax-free in terms of income as well as capital growth.
Past end dates for the ISA system have been eliminated and ISAs are now expected to be available indefinitely.
The cost to government of tax reliefs on ISAs is given as £2.2 billion in 2008-09 and £1.6 billion in 2009-10.
In April 1999, the Government introduced a voluntary CAT standard for ISAs (standing for "Charges, Access, and Terms") to make them easier for inexperienced customers to understand and with the proposed intention that lower costs would attract more investors. It does not guarantee the investment performance or that investors would buy or be sold the right type of investment. Many products comply with the CAT standard and there is some controversy as to whether or not the CAT standard alone would reach out to many more people who would not have otherwise chosen to save.
Cash ISAs have nevertheless been beneficial to savers through providing instant access savings that require little investment, meaning that the first £5,340 of any cash savings each year will be in a tax-free environment. By way of contrast, only the interest could be withdrawn from a TESSA before its five year period had finished or the tax free status would be lost. Further, due to competition cash ISAs continue (as at September 2004) to offer the highest rates of interest, irrespective of tax status, often meaning £1 in an ISA gains a higher rate of gross interest than many thousands invested in another account with the same provider. The market is further advanced as non-taxpayers still benefit from the use of cash ISAs due to the favourable interest rates.
Many equity funds also meet the CAT standards, but the restriction on costs generally means that these funds are index funds, which require little management and simply follow a given index, such as the FTSE 100 Index.
CAT standards were discontinued by the Treasury on 6 April 2005 following the introduction of the stakeholder product suite, although existing CAT standard ISAs continued on the same terms and conditions.
Transition and Older Types of ISA
PEPs became stocks and shares ISAs, with an exemption that allowed them to continue to hold investments that could not be held in a stocks and shares ISA, provided that the investment did meet the pre-2001 PEP rules.
New TESSAs could not be created after 5 April 1999, so the required five-year term of all TESSAs ended by 5 April 2004. TOISAs were created to allow the original capital (excluding interest) invested in a TESSA (up to £9,000) to be reinvested in a tax-free form. It was only possible to invest in a TOISA with the capital from a matured TESSA, and new TOISAs could be created only for the complete transfer of funds from another TOISA.
At introduction there were Mini ISAs, Maxi ISAs and TESSA-only ISAs. In the March 2007 Budget, the distinction between a Mini and a Maxi ISA was abolished. At this point the limits for the 2008/9 tax year were also increased.
An insurance component was available in both maxi and mini ISAs. However, since the 2005/06 tax year this component has not been available. Collective investment funds that once qualified for this component will have been reclassified as qualifying for either the Cash or Stocks & Shares component.
Similar schemes in other countries
- Superannuation in Australia
- Individual Retirement Account (IRA), the Roth IRA type is close except for its extra restrictions, and Roth 401(k) (United States)
- ^ a b "ISA Bulletin 2: Qualifying investments – db x-trackers - Sterling Money Market ETF". HM Revenue and Customs. http://www.hmrc.gov.uk/isa/isa-bulletin2.htm. Retrieved 24 November 2010.
- ^ "ISAs: Guidance Notes for ISA Managers". HM Revenue and Customs. http://www.hmrc.gov.uk/isa/isa-guidance-notes.pdf. Retrieved 23 October 2011.
- ^ a b c "HM Treasury confirms higher ISA limits for 2012-13". HM Treasury. 18 October 2011. http://www.hm-treasury.gov.uk/press_115_11.htm. Retrieved 23 October 2011.
- ^ a b "Rule changes from April 2008". HM Revenue and Customs. http://www.hmrc.gov.uk/isa/rule-change-april08.htm. Retrieved 24 January 2008.
- ^ "Complete Budget 2009 Report" (PDF). HM Treasury. 22 April 2009. p. 159. http://www.hm-treasury.gov.uk/d/Budget2009/bud09_completereport_2591.pdf#page=167. Retrieved 22 April 2009.
- ^ Hussain, Ali; Cooper, Kathryn (24 March 2010). "The budget’s winners and losers". The Times. http://business.timesonline.co.uk/tol/business/economics/budget/article7073698.ece. Retrieved 25 August 2011.
- ^ a b "Could you cash in on this ISA loophole?". Moneywise. http://www.moneywise.co.uk/news-views/2009/09/25/could-you-cash-isa-loophole. Retrieved 24 November 2010.
- ^ HMRC Estimated costs of the principal tax expenditure and structural reliefs
- ^ "CAT standards". HM Treasury. http://www.hm-treasury.gov.uk/press_95_04.htm. Retrieved 27 October 2009.
- Junior ISA Explained by Family Investments
Wikimedia Foundation. 2010.
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