The world of investments can often be highly complex and tricky, involving a number of complicated terms and concepts that won’t necessarily be familiar to those not part of the finance world. Nevertheless, there are a number of attractive avenues it may be worth informing yourself of in terms of tax-efficient investments, most notably in regard to Individual savings accounts (ISAs).
Individual Savings Accounts (ISAs) are just tax-efficient ways of saving money. There are 4 main types of ISA:
- Cash ISAs
- Stocks and Shares ISAs
- Innovative Finance ISAs
- Lifetime ISAs
Each year you can deposit a certain amount into an ISA. As of the 2023/24 tax year, this stands at £20,000.
You are permitted to have multiple different types of accounts open at the same time, as long as you pay no more than £20,000 into them in total each year.
Some specific ISAs offer special features and bonuses paid for by the government and for these the allowances are slightly different so it is important to note with a Lifetime ISA, you only have an allowance of £4,000. However, you will still have the total £20,000 available for other ISA products. For instance, in this tax year you could save £4,000 in a Lifetime ISA, £5,000 in a stocks and shares ISA and £11,000 in a cash ISA.
These are savings accounts, which will pay out tax-free interest on your invested savings, deposited as cash. This tends to be the most common and simple form of ISA. You can choose here between fixed rate and variable interest rates. Variable rates, while normally being lower, will allow you much more freedom when withdrawing money, while fixed rates generally provide higher interests rates, but will require you to keep your money invested for longer.
Stocks and Shares ISA
These share many similarities with cash ISAs, nevertheless, the main difference is that the money, rather than being held in cash, is invested into the stock market. There is no tax due for any investment returns. This can come with a lot of benefits compared with a cash ISA, giving you much more potential to grow your pot and make a profit. However, this isn’t necessarily a given, as the stock market can be volatile and leave you risking a loss.
Innovative Finance ISAs
Instead of stocks or cash, innovative finance ISAs (IFISAs) contain peer-to-peer loans. Put simply, peer-to-peer lending allows you to borrow or lend between people while cutting out the middleman, i.e. the bank or financial institution. These can be quite attractive, as they often contain higher interest rates than other forms of ISAs or savings, however, it is important to be aware of the risks involved. Peer-to-peer lending is a relatively new concept, only having been around since 2005 and as such many IFISA platforms only have limited protections, for instance in the event of the platform collapsing, there isn’t any protection offered by the Financial Services Compensation Scheme.
Lifetime ISAs are longer term investment accounts. You can only open them if you are between 18 and 40 years old, and once you’ve started contributing, you won’t be able to withdraw any money from the account until you turn 60 or purchase your first property. You have a maximum allowance of £4,000 per year that you can pay into the ISA, which can happen in any combination of stocks and shares. The government add a 25% bonus to your savings, meaning you could gain up to an extra £1,000 per year. Important to note, is that you can only contribute until you turn 50. After this, you can’t contribute or benefit from the 25% bonus, however, your savings will continue to benefit from interest or investment returns.
In terms of withdrawing from the account, there are three possibilities as to when you can do this:
- When you turn 60
- When you buy your first house
- If you are terminally ill
If you prematurely withdraw from the account for any other reason, then you will be required to repay the 25% government bonus.
Exactly which ISA works best for you is very much dependent on a number of factors including your risk tolerance, your situation, and your financial preferences. However, fundamentally, each form is a good example of tax-efficient investing that will allow you to gradually accumulate wealth. These are schemes that will help you improve your finances and help you establish financial security for the future.