ISAs offer great tax-free benefits, including the tax-free ISA allowance, and when it comes to saving money, one of the best vehicles on the market today here in the UK is the Individual Savings Account or ISA. Here in this article, we will be looking into the Stocks and Shares ISA tax benefits.
To find out why ISAs, in general, are so popular and so often recommended, you need to understand how they work, the tax rules, the ISA tax-free allowance, and the implications that come with all these aspects. So, let’s start with what they are, and then we can move on to taxes from there.
| Are there any tax benefits with a S&S ISA? | Yes, and they are quite significant |
| Do I pay tax on ISA withdrawals? | No, you don’t |
| Do you have to declare an ISA on your tax returns? | No, you don’t need to declare any interests or gains from your savings or investments when filing your tax return |
| Do you pay tax on Stocks and Shares ISA accounts? | As long as you stick within your personal annual ISA allowance of £20,000, your contributions will be completely tax-free |
What is an ISA?
An ISA, or Individual Savings Account, is a savings vehicle that is constructed in such a way that you ideally don’t pay tax on your returns. There is, however, one restriction. The amount of cash you are allowed to save or invest in an ISA in any one tax year – your individual annual ISA tax-free allowance – is set at £20,000 per annum. This figure has remained unchanged since 2017.
You might like to think of an ISA as a protective box – financial professionals refer to them as “wrappers”. Are ISAs tax-free? Yes, they are. Anything inside these “wrappers” is protected from HMRC. There are two base types of ISA – the Cash ISA and the Stocks and Shares ISA.
If you are aged 16 or over and are a resident here in the UK, you are entitled to save money into one type of ISA every year. The amount of money the taxman will allow you to save is known as your ISA allowance, or to give it its full name, your ISA tax-free allowance, and it is set at £20,000 per tax year.
Once inside an ISA “wrapper,” your cash cannot be taxed. It doesn’t matter how long it stays in there. Both the Cash and Stocks and Shares ISA tax positions are the same. The taxman cannot touch them.
As we mentioned above, there are two main types of ISA, the Cash ISA and the Stocks and Shares ISA. There are some other variations, however, and to understand these, you need to consider the five different ISA accounts, which are:
- Cash ISA
- Stocks and Shares ISA
- Innovative Finance ISA
- Junior ISA
- Lifetime ISA
For those who are happy to take a higher degree of risk, the innovative finance ISA is an option. If you aren’t particularly risk-averse, the Stocks and Shares ISA tax benefits, along with the potential for solid returns on your investment, make this type of ISA a shrewd investment tool. Funds invested in a stocks and shares ISA are usually covered by the FSCS (Financial Services Compensation Scheme), whereas money invested in an innovative finance ISA is not. The type of ISA with the lowest risk is the cash ISA.
What is the tax-free ISA allowance?
Are ISAs tax-free rules applicable to the ISA allowance? Well, the UK government sets a tax-free ISA limit on how much you can save each tax year. The ISA tax-free allowance limit for 2023/24 is £20,000. You can put the full amount into either a cash ISA, investment ISA (stocks and shares ISA) or innovative finance ISA.
You can’t put your ISA allowance into more than one of each type of ISA account in the same tax year, for example, two stocks and shares ISAs. However, you can spread the allowance across the five different types of ISA, but you’ll need to be aware of the UK 2023 tax year dates to ensure you use your tax-free ISA allowance before April 5th.
If you are splitting your tax-free ISA allowance across several types of ISA, please note that some ISA accounts are subject to individual account limits. For instance, Junior ISAs allow you to save up to £9,000 during the tax year, while Lifetime ISAs will enable you to put away £4,000 during the tax year. But the Junior ISA allowance does not affect your personal annual ISA allowance because the £9,000 allowance is for your child.
Are ISAs tax-free if they are already existing ISA accounts? The answer is yes, and you can choose to transfer your ISA by consolidating your old inactive accounts into a single new account. The transfer from previous years will not affect your ISA tax-free allowance for the current tax year.
Claiming back tax
Some types of savings products pay tax-free interest regardless of your income or any other savings interest you receive. It includes the fact that you don’t pay tax on dividend income. Having said that, the majority of savers no longer have to save into an ISA to earn tax-free interest because of the introduction of the personal savings allowance.
The individual tax allowance for the current tax year is £20,000, which means that as long as you stay within the stocks and shares ISA tax-free limit, you can still save tax-free even if you are an additional rate taxpayer.
If you suspect that you have paid more tax than you should have on your savings and investments, you will have to complete an R40 form which you can download from the GOV.UK website.
With interest rates on savings rising due to inflation and the cost-of-living crisis, there is an argument that the annual personal stocks and shares ISA tax-free allowance should be increased.
Fee charges on Stocks and Shares ISAs
Stocks and Shares ISAs often outperform other forms of saving – including Cash ISAs (but not necessarily the innovative finance ISA, which can offer the highest returns accompanied by the highest risk)– over the long term. Although the difference in interest rates can be significant, it may not be huge. However, if you’re not careful with how your Stocks and Shares ISA is set up, the fees that you are charged could make the proposition less attractive by eating into your profits.
What are the tax advantages of Stocks and Shares ISAs?
When all is said and done, the tax advantages of Stocks and Shares ISAs are significant. First of all, you have your £20,000 per annum ISA tax-free allowance. Then, the growth of your investments will not be subject to capital gains tax.
Do I pay tax on ISA withdrawals?
Are ISAs tax-free when you withdraw? Yes, you don’t lose any tax breaks by withdrawing cash from your ISA. Not only is the answer to the question, “Do I pay tax on ISA withdrawals?” no, neither will you pay taxes on ISA withdrawals from investment profit, interest, or dividend income in the UK.
The flexibility you have when withdrawing money from individual savings accounts depends on the type of ISA. You can take out money from a flexible ISA account without affecting your annual ISA allowance in the same tax year. The withdrawal flexibility is currently only available in the UK through Cash ISAs, Innovation Finance ISAs, and cash held within Stocks and Share ISAs.
Do you pay tax on isa withdrawals? Well, penalties or fees could be associated with withdrawing money from certain types of ISAs, such as a Lifetime ISA or non-flexible ISA. So be sure to keep that in consideration when choosing the best ISA that aligns with your needs and financial goals.
Do you have to declare an ISA on your tax returns?
No, you don’t need to declare any interest or gains from your savings or investments when filing your tax return. However, you mustn’t lose sight of the fact that ISA interest is tax-free and that you are exempt from ISA capital gains tax.
But don’t forget the £20,000 per tax year PSA. You’ll sacrifice tax-free interest on contributions above the threshold depending on your individual circumstances, whether you are a basic or higher-rate taxpayer.
What happens when I exceed my ISA allowance?
As we have explained, the answer to the question, “Do you pay tax on ISAs?” is no, you don’t, provided you stay within your annual ISA allowance. But if your contributions exceed the ISA tax-free allowance in any given tax year, you’ll be in trouble. You are likely to receive an unexpected call from the taxman.
All ISA providers are legally obligated to send details of all contributions to ISAs to HMRC. That’s why you, as an individual, are not obliged to include ISAs on your tax returns. If you realise you’ve overstepped the mark, you can report it to HMRC yourself by calling their ISA helpline on weekdays between 09:00 and 18:00, on 0300 200 3300.
Once HMRC is aware of any ISA allowance breach, they will begin a process known as “repairing the ISA,” which, in effect, means reclaiming the overpayments. If we are talking about a cash ISA, this process is quite simple. With a stock and shares ISA, however, it’s a little more complex, as fund units or shares must be sold.
If you spotted the error yourself before the end of the tax year in which you made the mistake, you can correct yourself by simply withdrawing the offending amount. You will, however, still receive a letter from HMRC, so be sure to keep details of any compensating withdrawal handy as you will need them.
Compound tax-free returns
A Stocks and Shares ISA is a tax wrapper that has been designed to protect your investments from both income tax and capital gains tax. Over a period of time, this can have a significant effect.
Do you pay tax on ISA interest? No, and if money is left in an ISA, it will be able to take advantage of the wonders of compound interest returns. In other words, the interest is added onto the investment, which grows and attracts even more interest year on year.
So, in answer to the question, “Are ISAs tax-free? – yes, they are. However, there is a but, and that but relates to the fact that there are some other types of taxes that could apply, as we are about to discuss.
Are ISAs tax-free regarding inheritance tax?
Sadly, ISAs are not always exempt from inheritance tax. But if you’re asking, are ISAs tax-free when inherited by a spouse? – The answer to that question is yes, your spouse or civil partner is exempt from inheritance tax. When you die, your spouse or civil partner will inherit the value of your ISA via an extra allowance called Additional Permitted Subscription (APS), and it is independent of their annual ISA allowance.
However, if you decide to leave your inheritance to another beneficiary besides your spouse or civil partner, then the person inheriting your assets will be liable for Inheritance Tax as, in this instance, ISAs do lose their tax benefit upon death.
Are ISAs tax-free if they form part of your estate when you die? Unfortunately, beneficiaries have to pay inheritance tax on ISAs that form part of an estate as long as they are not your surviving spouse or civil partner. In this case, as mentioned above, the spouse or civil partner receives an additional permitted subscription (APS).
It’s important to see a specialist solicitor for detailed legal guidance, as the answer to the question, “Is a stocks and shares ISA tax-free,” as far as inheritance tax is concerned, can be quite complicated.
Outmanoeuvring inflation
The spectre of inflation is a constant worry. It is ever-present, and unless your savings are protected, it can erode their value over time. It is certainly something to take into consideration if you have a cash ISA because, currently, interest rates are well below the rate of inflation.
According to the inflationtool website, in 2022, the 10-year average for the UK inflation rate was 2.30% per annum. However, in February 2023, it peaked at 10.4%, the highest it has been for 45 years. The rate has gradually fallen, and as of writing, it is 7.9%, but the best Cash ISA rate is still woefully short at around 4.3%, which means that money invested in this type of ISA is losing value in real terms. Are all ISAs tax-free? – Yes, they are, but even so, money left in cash ISAs does devalue.
In this situation, the Stocks and Shares ISA can come into its own right because the interest rates are generally much higher and regularly outperform inflation, meaning that in real terms, your money can be worth even more over the long term. However, you must bear in mind that with Stocks and Shares ISAs, investment values can go down as well as up.
To help you understand the Stocks and Shares ISA tax implications, we’ve created a short FAQ section.
FAQ
Do you pay tax on stocks and shares ISA accounts?
As long as you stick within your personal annual tax-free ISA allowance of £20,000, your contributions will be completely tax-free. You can spread your contributions across all five types of ISA or put the total sum of £20,000 into one type of ISA account. However, it would be best to remember that the maximum annual allowance with a junior ISA is £4,000.
The individual investor is responsible for ensuring that he or she does not exceed the annual isa tax-free allowance in any one tax year. If you think you may have done this accidentally, you should contact your ISA provider and HM Revenue and Customs. None of the overpayments will be entitled to any tax relief, and HMRC could penalise you.
Is Capital Gains Tax payable on stocks and shares ISA investment growth?
The situation with Stocks and Shares ISA capital gains tax is quite clear. You will not pay any tax on the growth of your investment or any returns or interest. In addition, you will not pay tax on dividends in your post portfolio, nor will you pay any capital gains tax on any profits your Stocks and Shares ISA makes.
Do I pay tax on Stocks and Shares ISA withdrawals?
If you are asking yourself, “Do I pay tax on ISA withdrawals from an investment ISA,” the answer is no, you don’t pay tax on Stocks and Shares ISA withdrawals. However, withdrawing money from a Stocks and Shares ISA tax-free wrapper and saving it in other types of investment accounts means that the money loses its tax-free status. Should you withdraw money from an ISA into which you’ve subscribed during the current tax year, the balance of your ISA allowance won’t be adjusted. It means that if you add those funds back in at a later date, they can still count towards your overall annual ISA allowance.
What about Stocks and Shares ISA tax on dividends?
Regardless of the size of any dividends you receive from the stocks and shares in your stocks and shares ISA, you will not have to pay tax on dividends.
Are Stocks and Shares ISA completely tax-free?
No, even though a Stocks and Shares ISA is a ‘tax-sheltered’ investment account, it is not totally tax-free. While the protection does include exemption from income tax and capital gains tax (CGT), the stocks and shares ISA tax benefits do not include protection from Stamp duty, Inheritance tax, or Corporation tax.
Do I need to declare ISA interest on my tax return?
No, you do not have to declare Stocks and Shares ISA (interest, income or stocks and shares ISA capital gains tax) on your annual tax return.
*As with all investing, financial instruments involve inherent risks, including loss of capital, market fluctuations and liquidity risk. Past performance is no guarantee of future results. It is important to consider your risk tolerance and investment objectives before proceeding.
