ISAs: A Guide to Tax-Free Savings

Making the most of your annual ISA allowance. As interest rates dive to record lows, there’s never been a more important time to get the best possible return on your money. Key to doing this is ensuring you don’t hand over more cash to the taxman than you have to.

But does that mean investing in an offshore tax haven or working out a tax avoidance scheme? Not at all. Tax-free savings simply means making the most of your annual ISA allowance. Read this guide for more information...

What is an ISA?

ISAs, or Individual Savings Accounts, were introduced in April 1999 to enable people to save a certain amount of money each year without having to pay tax on the gains they make, or the interest they earn.

In other words, ISAs are an incentive for you to save.

Savings levels

Consumers can currently save up to £7,200 each tax year into an ISA. They can either invest the full amount into stocks and shares, or they can save up to £3,600 in cash, with the remaining balance invested in shares.

No tax is paid on the interest earned through cash ISA savings, while any money built up in an equity or shares ISA is free of capital gains tax, although a 10% tax is still automatically charged on any income from share dividends.

Is it still worth it?

Historical data from the Bank of England shows that the average returns paid on ISAs are typically higher than on other savings accounts, and this is before the tax advantage.

But more importantly, paying tax on savings actually eats into the returns you’re getting. For example, a higher rate taxpayer needs to earn 1.67% on their savings just to equal every 1% they earn through an ISA, while a basic rate taxpayer would have to earn 1.25%.

As a result, a higher rate taxpayer would have to find a rate of 5.01% on a normal savings account to equal an ISA rate of 3%. In the current climate, returns of 5% are hard to find, showing the benefits of using an ISA.

Although the tax-free returns benefit may not seem huge when you’ve saved only one year’s worth of the allowance, it will be fairly significant by the time you’ve tucked away £3,600 a year, plus interest, for 10 years!

Where to get an ISA

As with other savings accounts, shopping around for the best rate is key. You can find a selection of cash ISAs and shares ISAs on the Confused.com ISA page.

You can only pay into one cash and one shares ISA each tax year, so it pays to pick a good one.

If you already have an ISA but are worried that it’s no longer offering the best returns, you can move your savings into a new account. But it’s important you get your existing provider to transfer the funds for you. This will ensure you don’t lose the ISA status on the money you’ve already saved.

It’s also possible for people to transfer the money they’ve saved in a cash ISA into a shares one, although money in a shares ISA can’t be transferred to a cash one.

Sourced from Confused.com [Link]