Taking out an ISA is an ideal way of putting your savings to good use. So, what exactly are the core ISA benefits? In this article, we’ll explain exactly what an ISA is, which one to choose depending on your circumstances, and the benefits of opening one over the long term. To find out more, please read on.
| How much ISA allowance is tax-free? | £20,000 |
| Is ISA right for you? | It depends on your risk tolerance and financial goals |
| Benefits of a Stocks and Shares ISA? | •Good returns •No income tax •Dividend tax •Capital gains tax •Simplified tax return |
| Benefit of stocks and shares ISA? | The interest rate is better than a traditional savings account |
What exactly is an ISA?
The acronym ISA stands for Individual Savings Account. It is a tax-efficient vehicle that allows investors to save and invest up to £20,000 per tax year. There are five common types of ISA:
- A Cash ISA
- A Stocks and Shares ISA
- An Innovative Finance ISA
- A Junior ISA (JISA)
- A Lifetime ISA (LISA)
The £20,000 tax-free allowance is the total sum you can invest annually in a single ISA or across all types, except for Junior ISA and Lifetime ISA, where the annual tax-free allowance is only £9,000 and £4,000, respectively.
You should be aware that if you do not use all of your annual allowance for any given tax year, you cannot carry it over to the next year, unlike the annual allowance for pension contributions. With ISAs, it’s a case of use it or lose it.
Which is the right ISA for you?
When deciding which ISA is right for you, it all depends on your personal goals and how much risk you are willing to take on. Here are a couple of questions you will need to ask yourself to identify the right ISA for your goals.
Ask yourself why you want to save
The first thing to get to grips with is your motivation for saving. What are your targets? What are you looking to achieve? Are you thinking long-term or short-term? Will you put money away monthly, yearly, or in one lump sum?
You also need to consider whether you will need regular access to your funds or whether you are prepared to lock them away for your retirement. For longer-term investments, we will eventually look into the Stocks and Shares ISA benefits.
How risk-averse are you?
The two most common types of ISA are the Cash ISA and the Stocks and Shares ISA. The key difference between these two is that, while a Cash ISA works in much the same way as a traditional savings account, a Stocks and Shares ISA works by investing your funds into various assets with a view to achieving financial growth over the long term.
We will look into the Stocks and Shares ISA benefits shortly, but first, a brief word about risk. Whereas money saved in a Cash ISA is relatively safe, the funds you invest in a Stocks and Shares ISA can go up or down. So it really all depends on your attitude to risk.
What are the benefits of a Stocks and Shares ISA?
Exploring the benefits of stocks and shares ISA can significantly impact your investment strategy, and understanding these benefits is crucial for any investor looking to maximize their financial potential.
The ISA benefits vary depending on the type of ISA you decide to take out, but the main benefit of all of them (apart from the JISA) is the tax-efficient way to grow your investments via the £20,000 per year tax-free concession.
The problem with ordinary savings accounts, which also applies to Cash ISAs, is that their interest rates are very low. But one of the biggest benefits of Stocks and Shares ISA accounts is that they have the capacity to outperform Cash ISAs significantly in the long term. It all boils down to that horrible four-letter word—risk.
The other name for a Stocks and Shares ISA is an Investment ISA, with “investment” being the operative word. A Cash ISA is not an investment as such; it’s akin to a savings account. With an Investment ISA, however, you are investing your money into stocks and shares. For some people, this puts them off when they think about the potential volatility of financial markets.
When considering the Investment ISA benefits, you must look at the bigger picture. The advantages of Stocks and shares ISA or an ISA in general include:
An easy way to begin investing
Many people shy away from opening a Stocks and Shares ISA because they think dealing in equities is too complicated. However, this is no longer the case with the arrival of robo-investing services and digital investment products. They do all the hard work on your behalf.
A robo investor will build a portfolio to suit your individual needs and will do the necessary legwork to monitor and change your portfolio when and where appropriate. Going down the DIY route allows you to spend more time doing the things you like while your robo-adviser does the hard work of managing your account.
The ability to keep more of your returns
UK residents pay two taxes on their investment returns – Income Tax and Capital Gains Tax. One of the primary benefits of stocks and shares ISA is the tax efficiency it offers. You are given an annual ISA allowance of up to £20,000; these contributions are not taxed. Also, any gains from your investments in this ISA are free from capital gains tax, and there is no tax on dividend income, which can lead to a substantial increase in your investment returns over time.
Another benefit of an Investment ISA account is that you get to keep more of your hard-earned money and spend less time preparing a self-assessment tax return.
Flexibility
Another key advantage is the flexibility that a stocks and shares ISA provides. Unlike pension savings, you can withdraw your money at any time without penalty, making it an attractive option for investors who want both growth potential and access to their funds. This flexibility is a key benefit of ISA that many savers value. Moreover, the benefits of stocks and shares ISA include the ability to transfer in from other ISA types, giving you the flexibility to move your savings around as your investment goals change.
Diversification
The benefits of stocks and shares ISA also extend to the wide range of investment options available. You can choose from a variety of assets to include in your ISA, from individual stocks and shares to bonds and funds, allowing you to tailor your investment strategy to your risk tolerance and financial goals.
Delivering higher returns
Although there have been some small increases recently, the interest rates on cash savings here in the UK are still poor. Typically, they remain under 2%. Despite that, Brits keep on putting their money into Cash ISAs.
The use of Cash ISAs is clear from the point of view of easy accessibility, the ability to pay unexpected or emergency bills, and so on. However, by putting all of your money into this type of savings account, you are not taking advantage of the amount the potential interest your money could earn for you in the long term.
The fact of the matter is that, with inflation peaking a little bit above the bank of interest base rate, the value of money tied up in savings accounts is likely to decrease in real terms. In other words, your money is underperforming.
Your long-term financial targets may never be fully realised in limbo like this.
The advantage of ISA investments in stocks and shares is that rather than relying on a low fixed interest rate as with a Cash ISA, you can reap the reward of how much your stocks and shares investments are worth when it comes time to sell them. While there is a risk that you might have to settle for less than you originally invested, there is also an excellent chance of making inflation-beating returns over time.
Is it worth taking out a Stocks and Shares ISA?
Now we’re coming down to the crunch. There is an awful lot of scaremongering going around, and this has to be put into perspective. Is it really worth taking out Stocks and Shares ISAs? Well, one way of answering that question is to look back over what has happened in recent years.
According to the moneytothemasses, the recent history of Stocks and Shares ISA performance is actually very encouraging, highlighting the benefits of stocks and shares ISA.
In the tax year 2017/2018, Stocks and Shares ISAs showed a return on investment of 4.8%. In the following tax year, 2018/2019, the figure was 4.04%. To put that into perspective, we need to compare that to Cash ISA performance. The average interest rate for both fixed and variable-rate Cash ISAs was only 1.01%. Put them side by side and the significant advantage in favour of the Stocks and Shares ISA begins to show, underscoring the stocks and shares ISA benefits.
The Covid-19 variable
There are always fluctuations in the world of economic markets, and there always will be. Once upon a time, there was the Wall Street Crash, and then there was the subprime mortgage crisis between 2007 and 2010, when the bottom fell out of the markets.
Of course, there has been the Coronavirus pandemic more recently, and indeed, it is far from over, although we can now see a light at the end of the tunnel – at least here in the UK.
The great thing is that financial markets have always recovered, although it might take time. This is why it is always recommended that Stocks and Shares ISAs be considered long-term investments. If you don’t have to access your funds during times of financial crisis, your portfolio will likely weather the storm.
Having a competent professional wealth adviser in your corner is a big plus.
FAQ
What is the best type of ISA?
The best type of ISA is an investment ISA because due to its high rate of return. Despite being the most popular ISA variant, cash ISAs have lower returns than investment ISAs. The three types of investment ISAs include stocks and shares ISA, lifetime ISA, and innovative finance ISA.
Are stocks and shares ISA tax-free?
One of the benefits of stocks and shares ISA is that you don’t pay tax on interest earned on cash investments held in an ISA. You also don’t pay income or capital gains tax on gains from investments in an ISA account.
What are the disadvantages of a stocks and shares ISA?
Stocks and shares ISAs are not ideal for short-term investments. Due to market volatility, their value can appreciate and depreciate. In addition, there are fees and charges associated with stocks and shares ISAs. They include management fees, exit fees, platform fees, etc. You can’t carry the ISA allowance forward to the next tax year or have joint names on an ISA account.
*Capital at risk. Tax treatment depends on your individual circumstances and may be subject to change in the future.
