Individual Savings Account

An Individual Savings Account (ISA; /ˈaɪsə/) is a class of retail investment arrangements available to residents of the United Kingdom. It qualifies for a favourable tax status. Payments into the account are made from after-tax income. The account is exempt from income tax and capital gains tax on the investment returns, and no tax is payable on money withdrawn from the scheme either. Cash and a broad range of investments can be held within the arrangement, and there is no restriction on when or how much money can be withdrawn.Funds cannot be used as security for a loan.^[1] It is not a pension product, but can be a useful tool for retirement planning.^[2][3]

Origins

ISAs were introduced on 6 April 1999, replacing the earlier Personal Equity Plans (PEPs; very similar to a Stocks and Shares ISA) and Tax-Exempt Special Savings Accounts (TESSAs; very similar to a Cash ISA). Other tax-advantaged savings that also predate ISAs include many offered by National Savings and Investments, which is a state-owned institution which has in the past offered a range of other tax-free accounts, in addition to its own ISAs.

Junior ISAs also replace the Child Trust Fund.^[4][5]

With a few exceptions, such as from an employee share ownership plan, all investor contributions must be in cash, not kind. Adult ISAs are available to UK residents aged over 16, provided that they have a National Insurance number, but individuals between 16 and 18 are only permitted to use the adult cash component or can use a Junior ISA.

There are two broad types of ISA, cash or stocks and shares.

Cash ISA

An account which enjoys tax free status, usually deposits with £75,000 Financial Services Compensation Scheme (FSCS) protection but client money with £50,000 protection or unprotected money is also permitted; the providers are required to make the protection clear.^[6] These are normally offered by banks and building societies but investment firms can also offer them. It is mandatory that money held in a cash ISA be made available on request within 15 days but it is permitted to have a loss of interest penalty for this and this is how term deposits are typically made available.^[7]

A cash ISA can also hold qualifying investments that failed the 5% test for holding within a stocks and shares ISA^[8] before 1 July 2014^[9] when the test was removed but this facility was rarely, if ever, made available by a cash ISA provider. Such investments would not be deposits and would not have the deposit FSCS protection, they may have the £50,000 investment protection instead, the provider must make the situation clear.

Stocks and shares ISA

The money is invested in 'qualifying investments'. Qualifying investments are:^[10]

1. cash
2. UCITS authorised funds like unit trusts and open-ended investment companies.
3. investment trusts that satisfy various possible conditions
4. 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. From 5 August 2013, AIM shares are allowed in ISAs.^[11]
5. public debt securities such as government, corporate bonds, debentures and Eurobonds.
6. From 1 July 2014, some Core Capital Deferred Shares issued by building societies, some types of insurance policy and other investments that previously failed the 5% test.

It is mandatory that money held in a S&S ISA be made available on request within 30 days but it is permitted to have a loss of interest penalty for this.^[7] A S&S ISA with a deposit facility may impose a loss of interest penalty to comply with this requirement.

Junior ISAs

Junior ISAs were introduced on 1 November 2011 with an initial subscription limit of £3,600, which was increased to £4,000 in July 2014^[12] and to £4,080 for the 2015-16 tax year. At age 18 the JISA converts to an adult ISA.^[13] 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 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 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.

Subscription limits

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:

1. The limits are per ISA management firm, not per account, so you can have many accounts with current year money at one manager. Simple descriptions often use account wording but the actual rules are more flexible and some managers use the flexibility.
2. No more than the annual amount limit can be paid in and the amount that can be in cash used to be restricted in an adult ISA. Any amount not used for cash can be used in other types of ISA.
3. Newly subscribed (paid in) money in the current tax year can only be held with up to one cash ISA manager and up to one stocks and shares ISA manager.

   An ISA manager can have multiple accounts that can each hold current year money. For example, current year cash ISA subscription money can be held in a Help to Buy account, instant access accounts, fixed rate accounts, variable rate accounts and deposit accounts with the same cash ISA manager even though this is five or more accounts. The single manager is what matters. The introduction of the Help to Buy cash ISA has made this flexibility within one manager's accounts more significant because it can't use the full cash limit.

4. Provided the annual contribution limits are not exceeded significantly HMRC can be expected to forgive one transgression using too many ISA managers/accounts and merely post a letter reminding about the rules after the annual returns from ISA providers reveal the problem.^[14] 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 ISA managers' accounts can hold money from past years and it can be freely moved between managers using ISA transfer requests.

In the March 2010 Budget the then Chancellor of the Exchequer Alistair Darling announced that in future years the limits would rise annually with inflation,^[20] rounded to the nearest £120, to ease the arithmetic for those using monthly payment schemes. From 2013–14 the inflation index used is changing from RPI to CPI.

The Chancellor of the Exchequer George Osborne announced in the March 2014 Budget that the adult ISA limit would be increased to £15,000 from 1 July 2014, and the Junior ISA limit to £4,000. From that date savers will be allowed to invest the full amount as cash or stocks and shares, or a mix of both. Savers will also be able to switch stocks and shares ISAs to cash ISAs.^[21]

Transfer rules

Transfers between providers are allowed. A transfer from a Cash ISA to another Cash ISA must usually be completed within 15 business days. Any other type of account transfer must usually be completed within 30 days.^[22] There are a range of restrictions and workarounds:

• The transfer must be carried out by the managers. If a saver withdraws the money from the existing manager, the subsequent reinvestment will be treated as a new ISA subscription and is subject to the current year's subscription limit. As a concession 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.^[23]
• When transferring it is still necessary to comply with the rule that you can have only one cash ISA manager and one S&S ISA manager in use 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 manager. 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 already used for current year money. After the transfer to S&S the money counts against the S&S limit, not the cash limit.^[23]
• Before transferring stocks from one ISA manager/platform/provider to another it is worth checking that the new provider will accept all the stocks held in your ISA. Providers have different criteria for deciding if a particular stock can or cannot qualify for ISA status within their platform and you may have little choice but to liquidate that stock or withdraw it from the ISA wrapper.
• For current year money 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, subject to the annual contribution limit. This allows you to circumvent "new money only" restrictions imposed by some cash ISAs that will not accept transfers in, provided you have sufficient annual allowance available.
• Older products:
  • Whether the original contributions were made to a maxi ISA or a mini ISA has no effect on transfer.
  • Cash within a TOISA is treated as a cash component, and can be transferred to a "normal" cash ISA.

Tax treatment

Interest on deposits in a cash ISA is not taxed, whether it is an instant access or term deposit. Nor is interest on cash in a S&S ISA.

Dividends are not subject to additional tax, interest on bonds is not taxed, and capital gains are not taxed (nor may capital losses be used to offset other gains).

There is no need to report interest or other income, capital gains or trades to HMRC as it is not 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 capital gains tax to pay.

Since the income is not taxable it did not count for age-related personal income tax allowance reduction when that extra allowance existed.

Fund Supermarkets and Self Select ISA providers

There is no legal distinction 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 who focus on 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 offer only collective investment funds. An individual may not be the provider for their own ISA.^[10]

Except for fund houses, it is usual for providers to offer the facility to hold funds managed by many different organisations.

Prior to the effect of the Retail Distribution Review it was normal for S&S providers to be paid by 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. This is now prohibited for new customers who must be charged a fee instead. In the current transition period existing customers may be able to hold a mixture of commission paying investments and the "clean" versions that do not pay commission, perhaps paying a platform fee only for the clean portion. Some providers have chosen to be clean only. Some commission may be rebated to customers but this is not required.

Examples of ISA providers that have been identified as good by The Lang Cat and Investors Chronicle^[24] are in order of mention Hargreaves Lansdown's Vantage Service, AJ Bell Youinvest, Charles Stanley Direct, Bestinvest's Online Investment Service, Barclays Stockbrokers, TD Direct Investing, Alliance Trust Savings, Interactive Investor and The Share Centre.

Charges

The ISA cash component normally has no disclosed charges. The company can make money from the differences between its deposit and lending rates, fees, differences between wholesale and retail deposit rates or other means. For example, Hargreaves Lansdown quoted a 0.8% profit margin on cash held in its Vantage platform in spring 2014. 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.

Flexible ISAs and Innovative Finance ISA

Two of the planned changes which are scheduled to be introduced from April 2016 are:

• Innovative Finance ISA. The IFISA will be another sub-type of ISA similar to cash and S&S ISAs but designed to be used for peer-to-peer lending investments. Draft legislation has provided for only 36H compliant P2P but discussions are said by participants to be under way that may lead to including non-36H P2P lending. Equity-based P2P like crowdfunding is not included in the eligible products for this type of ISA.^[25]
• Flexible ISAs are an optional add-on feature for any adult ISA type that allow withdrawing cash and redepositing it in the same tax year. Providers are not required to implement the flexibility feature. A person will be able to withdraw an unlimited amount of money from an account and return up to that amount within the same tax year without it counting against the annual subscription limit. A person with £100,000 of past year money could withdraw say £90,000 on 15 April and redeposit it as desired within the tax year. If a transfer is done the firm receiving the transfer is told only the amount of current year allowance used, if any. None of the amount above the annual allowance can be paid into the new place but it can still be paid in to the original one, with that account being able to be reopened to allow this if it was closed.^[26]

Restrictions removed from July 2014

Many restrictions were significantly relaxed from 1 July 2014^[22] and the branding^[27] "New ISA" was introduced for this batch of changes:

• There was a ban on transferring from S&S ISA to cash ISA. Cash to S&S was allowed from 2008/2009. A JISA could always go in both directions.
• Interest on cash in a S&S ISA is no longer subject to a 20% charge. All cash in a S&S ISA is subject to the FCA client money rules and cash ISA providers can opt in to this if they wish.^[6]
• Cash can now be held in a S&S ISA even when not intended for investment. There was no specific time limit on how long cash could be held under the old rules, just whether the ISA manager believed the money was being held for future investment.
• The S&S ISA had a five years remaining at time of purchase restriction on public debt securities such as government, corporate bonds, debentures and Eurobonds. Conditional redemption, such as that based on possible future market performance, was acceptable, as was the borrowing company or government redeeming the security early or exercising of options if there are defaults, insolvency risks or covenant breaches.
• The S&S ISA had a requirement for a credible possibility of losing at least 5% of the investment, called the 5% test.^[8] Investments that failed the test had to be held in a cash ISA instead.

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.

For some time there were Mini ISAs, Maxi ISAs and TESSA-only ISAs. A Mini ISA could hold cash OR stocks, potentially many if operated by a fund house or platform, while a Maxi ISA could hold cash AND stocks. Any UK resident individual aged 18 or over could invest in one 'maxi' ISA per year, 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. In the March 2007 Budget the limits for the 2008/9 tax year were also increased.^[15] From tax year 2008/2009 the distinction between a mini and maxi ISA was abolished.

An insurance component was available in both maxi and mini ISAs. 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.

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. One could only invest in a TOISA the capital from a matured TESSA, and new TOISAs could be created only for the complete transfer of funds from another TOISA.

CAT standards

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 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.^[28]

Similar schemes in other countries

Non-pension products:

• Tax-Free Savings Account (TFSA) (Canada)

Pensions:

• Superannuation in Australia
• Individual Retirement Account (IRA), the Roth IRA type is close except for its extra restrictions, and Roth 401(k) (United States)
• Japan has NiSA accounts, with the system modeled after the UK and an annual cumulative limit of 1 million yen.

References

External links

• Individual Savings Accounts (ISAs)
• Junior Individual Savings Accounts (ISA)