The tax benefits of an ISA explained

One of the primary reasons people choose an ISA is the tax benefits. Every tax year, UK investors can put up to £20,000 away and have any returns shielded from tax.

Between 2011 and 2017, this annual limit increased from £10,200 to £20,000, where it remains today. This means that, over a 25 year period, an investor with the means to do so could save half a million pounds and pay absolutely no taxes on the profits.

A lot of people, however, are unaware of how impactful those tax savings can be. So, what are the biggest tax benefits of investing in an ISA?

You won’t pay tax on dividends from shares

Inside your ISA wrapper, all dividend income is completely tax-free. Outside of an ISA, only the first £2,000 you earn every year is free from tax and beyond this, the amount you pay is based on your income tax band. That’s 8.75% for basic-rate taxpayers, 33.75% for higher-rate taxpayers and 39.35% for additional rate taxpayers. But from the 2023/24 tax year, the dividend allowance will be reduced to £1,000.

You won’t pay any tax on interest from bonds

These returns are protected within your ISA wrapper. Assets like corporate bonds, which are more present in lower-risk portfolios, rely on interest for their returns. This is similar to the interest one earns in a bank account.

You won’t pay any capital gains tax

The tax allowance for capital gains outside of an ISA wrapper is currently £12,300. For the 2023/24 tax year, the Capital Gains Tax (CGT) annual exempt amount will become £6,000 and will be fixed permanently to £3,000 from the 2024/25 tax year. Inside a stocks and shares ISA, you’ll pay absolutely none. For basic-rate taxpayers, capital gains tax is 10%. For both higher-rate and additional-rate taxpayers, it’s 20%.

Depending on the size of your investment portfolio, these ISA tax benefits can have a huge impact, particularly over time.

So, why not take full advantage of the ISA allowance and tactically position your money to grow tax-free? We’ve spoken before about the potential for investment portfolios to help protect against inflation, but the efficiency of ISA tax benefits is yet another reason to get on top of your finances.

With your Moneyfarm account, you can have multiple ISA portfolios within the same tax wrapper. This means that you can have a number of different pots for different financial goals. Whether it’s retirement or putting your child through university, having a tax-efficient way to do both can make a huge difference.

With your Moneyfarm account, you can have multiple ISA portfolios within the same tax wrapper. This means that you can have a number of different pots for different financial goals. Whether it’s retirement or putting your child through university, having a tax-efficient way to do both can make a huge difference.

What happens to ISA tax benefits after the ISA holder’s death?

What happens to the ISA tax benefits is the question that many ask when someone close to them passes and leaves them their ISA fund.

Upon an ISA holder’s death, a surviving spouse or civil partner can inherit the money left in the deceased partner’s ISA via an additional personal subscription or APS for short. An APS transfers the money to the recipient’s ISA. If there isn’t one, one will be opened.

The APS system came into being expressly to allow a surviving spouse or civil partner to continue to enjoy tax-free income and fund growth from the inherited money. The value of the APS will be equal to the value of the deceased’s ISA at the time of their death.

What happens is that the inheritor’s ISA allowance for the year in which the transfer takes place is increased by the amount of the APS. This is a one-off event and must, therefore, include the full amount of the inherited money, tax-free. The following year, the inheritor’s ISA allowance returns to the £20,000 per annum norm. Once transferred, the funds can continue to enjoy tax-free growth.

Other friends or relatives to whom ISA money is bequeathed may have to pay Inheritance Tax (IHT) depending on the size of the deceased’s estate.

If you want to discuss your options or talk through your financial goals in more detail, don’t hesitate to get in touch with a Moneyfarm investment consultant.

FAQ

Do I have to pay tax on an ISA?

No, an ISA is tax efficient. Interest earned in a cash Isa is tax-free. You don’t pay income tax on interest and capital gains tax on interests earned on investments held in an ISA. Withdrawals are tax-free, and ISAs are also free of dividend tax.

What is the tax allowance of an ISA?

The ISA tax-free allowance for 2022/23 is £20,000. However, the excess amount will be subject to tax if you exceed the ISA limit of £20,000.

What happens to my ISA tax benefits when I die?

When you die, your ISA loses its tax-free status upon account closure or upon the completion of the administration of your estate. Otherwise, your ISA account will be closed by your provider 3 years and 1 day after your death, but it will maintain its tax benefits until account closure. If you died on or after 6 April 2018, your spouse or civil partner could inherit the value of your ISA tax free. This inherited one-off ISA payment is called “Additional Permitted Subscription (APS)”.