By elmads

Introduction

Saving money has been essential for the growth of the people, as it gives us more options for where to use our saved money, plus it signifies the prioritisation of our current and future needs. Yet, even if saving money grants us vast options and the betterment of our lives, there is still a percentage of our world population who do not save money. Or, even if they save it, they only save less than 5% of their salary, which is less than the average savings rate worldwide.

In the UK, the government tried to spur and help their residents increase and encourage saving their money by opening non-taxable accounts. It has actually been a great plan, because who would not like that? It is literally our money being untouchable by the taxman. This became not an immediate success but a success over time, even up to this day, as more and more people are learning to save and invest their money. Plus, because of ever-increasing basic living expenses, people understand how powerful saving money is.

As I have previously said, all types of Individual savings Accounts are non-taxable. The returns from our investment, either from

• Capital gains (the gains when our buy-level price increases and we sell at a higher price)
• Interest gains (usually bonds and certificates of deposit)
• Dividend gains (usually from stocks, funds, and ETFs)

All of them are 100% exempt from tax as long as our money is inside the ISA, plus we also do not pay any tax upon withdrawal of the money, provided that we follow the withdrawal restrictions stated on each ISA account that we have.

Without further ado, I’ll be showing the four types of Individual Savings Accounts (ISAs).

Types of Individual Savings Accounts (ISAs)

Cash ISA

It works literally just like any other bank savings account, except we do not pay taxes on the interest that we earn from it. When you look into a bank’s savings account, you’ll always encounter an interest income named “Gross interest income”. That’s called gross because taxes will still need to be deducted on that before they give the net interest payment. With a cash ISA, the interest payment that we will receive will be as it is because there will be no tax deducted anymore.

Who offers a cash ISA? Just like any savings account, cash ISAs are also offered by banks, building societies, and online banks. Check moneysupermarket.com’s Cash ISA online bank providers for comparison: https://www.moneysupermarket.com/savings/cash-isas/

Downside: Don’t expect a substantial interest rate from Cash ISAs because they are mostly the same as ordinary savings accounts.

Stocks and Shares ISA

As the name implies, this is an investment account type of ISA. Here, we invest our hard-earned money into equities such as stocks, equity mutual funds, UITFs, equity ETFs, and also bonds. All gains within this account are non-taxable. If you want to know more about Stocks and Shares and bonds, see my blogs regarding these two. “Stocks & Shares”, “How Shares are made and how the Stock Market works” and “The Bonds Asset Class”.

Who offers the Stocks and Shares ISA? There are a lot of providers for this ISA; most investment brokerages in the UK offer it. Browse online and make sure to do your research before opening an account because there are specific fees for buying and selling, management fees, platform fees, and others. It is literally the same as the taxable or ordinary investment brokerage accounts, except that this is non-taxable.

Downside: Just like any other investment, there is a risk of losing our invested capital if we do not study our investments.

Lifetime ISA / LISA

This is a bit different from the previous ISA because here, the maximum capacity in a year that a person could place into this account is only £4,000.

I’ll breakdown each category for it to be more understandable.

LISA is a non-taxable account that lets us save £4,000 per year, plus the government adds another 25% on every amount that we put in this account. Yes! You read it right; the government will add money to it. haha! You’re shocked, isn’t it? That’s what I felt as well from the first time I learned this information. See the infographic example below.

That in mind, if we always save the maximum capacity of £4,000 per year on a LISA, then we’ll automatically be receiving £1,000 in additional free money from the government because 25% of £4,000 is £1,000. So all in all, the maximum amount that we can amass in a year in a LISA is £5,000, and that is before interest and growth. BOOM! What a lovely incentive for UK residents, isn’t it? but it is not always rainbows and butterflies.

The downside:

1.) We can only invest in it from 18 to 50 years of age. So, if we have started saving or investing money in a LISA since we were 18 years old, that gives us 32 years of saving or investing horizon, which is up until we are 50 years old (50 minus 18 = 32). Also, if done with calculations, the maximum money that the government will be able to give us from 32 years of saving or investing in a LISA is £32,000 in the consideration that we place the maximum deposit limit of £4,000 per year since 18 years old.

Here is the computation: £4,000 x 25% = £1,000 max money that the government can give based on the max limit of deposit on our LISA.

£1,000 of maximum additional government money per year x 32 years of LISA saving and investing horizon = £32,000.

2.) Unlike Cash ISAs and Stocks and Shares ISAs, in which we can withdraw our money anytime that we like, in a LISA we cannot. There are only four instances in which we can take our money out of a LISA.

• For buying your first home: This is one of the main reasons why people choose LISA; it gives first-time home buyers the ability to save more cash because of the 25% added money by the government, plus interest gains from both self-saved money and the additional money the government will give.

NOTE: It says first home, so it literally means first home in the whole world. If you already have a home not just in the UK but also outside the UK, then you will not be eligible to use the money in your LISA to purchase a home in the UK. The home you plan to purchase should be in the UK, equal to or less than £450,000, and you can only buy the home with a mortgage, not cash.

• Retirement: We can only tap into it when we reach 60 years old and above. The best part here is that we do not need to pay any tax when we withdraw our money from it.
• If we have a terminal illness
• If we die, don’t worry, the money from our LISA will be given to our family members, but it will be taxed as an inheritance because it will be considered an estate.

On the other hand, is it still possible to withdraw from our LISA without meeting the four criteria? Yes, we can, but we will get taxed on 25% of the money we withdraw from our LISA.

In addition, there are two further LISA categories that we need to know about: the Cash LISA and the Stocks and Shares LISA.

Cash Lisa is the same as the Cash ISA; we save money and gain interest rate returns, while the Stocks & Shares LISA is for investing our money in paper assets like stocks and bonds. All returns within this account are, as usual, tax-free. Both LISAs will have the perks and disadvantages of the LISA plus whatever you choose between Cash LISA or Stocks & Shares LISA.

Innovative Finance ISA / IFISA

Here, we will be lenders to other people who need financing. The company where we will open an IFISA will use our saved money in the account to lend it to borrowers. (This is also known as peer-to-peer lending.)

The idea is to get interest income from the payments of the borrowers. It is actually just like bond investing, but instead of large companies and governments borrowing our money, it will be Small and Medium Enterprises (SMEs). The IFISA company provider will take a cut of the interest income we will receive. But the interest income will not be taxed by the government as long as it is inside the IFISA.

Withdrawal varies because the contract from the debt is with us (just like a bond contract), so that means we need to sell that contract to other buyers in order to exchange it for cash. It basically means that we need to sell our investment to others. This itself may take time, depending on the ratio of buyers and sellers. If there are fewer buyers than sellers, then it will take a longer time before we can exchange our investment for cash.

Downside: the risk that the borrower will default, meaning they will not be able to pay us anymore. This can cause our IFISA investments to have negative returns.

General ISA Notes

We can have the 4 ISAs all together, which means we can have a cash ISA, a stocks and shares ISA, a lifetime ISA, and an innovative finance ISA. The only important part that we have to take into consideration if we are planning to take all of these accounts is the deposit limit.

For this tax year 2021-2022, the maximum amount we can deposit is £20,000, which means that the total amount of the four accounts we have or plan to open should not exceed £20,000.

For instance;

• Cash ISA: £5,000
• Stocks & Shares ISA: £6,000
• Lifetime ISA: £4,000 (this is already the maximum deposit per year for this kind of ISA).
• Innovative Finance ISA: £5,000
• Overall ISA total: £20,000

This is what you call ISA sharing. This is just an example; it will still be up to you to determine your own ISA allocation plan and strategy. It is up to us if we want to open all four different ISAs, or three, two, or just one.

Furthermore, every person in the UK can open an ISA, but there is only one provider per type of ISA. Let’s say that we opened a Cash ISA in Barclay’s bank, and then we cannot open another Cash ISA in another bank anymore. But we can still open a Stocks and Shares ISA, Innovative Finance ISA, and Lifetime ISA with a different provider; it doesn’t necessarily need to be with Barclays Bank.

If we exceed the maximum threshold, then expect Her Majesty’s Revenue and Customs (HMRC) to contact us either soon or at the end of the tax year. See the link provided in order to be updated on the possible yearly changes to the ISA deposit limit: https://www.gov.uk/junior-individual-savings-accounts.

But wait, there’s more. ISAs were not made just for adults; the government also made one for children.

Junior ISA / JISA

This is an ISA specifically for saving money for our children’s future, commonly for university education. Parents can choose between Cash JISA and stock and share JISA.

For the age to open an account, Parents are the ones who can open an account if their child is aged 0–15, but if the child is aged 16–17, then they can open an account for themselves.

NOTE: Once the child turns 18 years old, the money in their JISA will be rolled over and changed automatically into an adult ISA (regardless of whether the parents or the child opened the JISA).

Annual deposit limit of £9,000 as per tax year 2021/2022. This is the maximum amount of money that can be deposited in a JISA, and it can change depending on the government’s yearly JISA allowance. To be updated, always check the UK government website regarding JISA; see the link provided at https://www.gov.uk/junior-individual-savings-accounts.

Also, we can deposit money on both Cash JISAs and Stocks and Shares JISAs as long as the total amount of both JISAs does not exceed the year’s deposit limit. As an example, the Cash JISA has £3,000, while the S&S JISA has £6,000, making a total of £9,000 for both JISAs.

JISA withdrawal has its own requirements.

• Firstly, it cannot be withdrawn unless the child reaches 18 years of age, but it is open and is managed by the parents.
• Secondly, once the child reaches 16 years old, he or she can now manage the account himself or herself but will still be unable to withdraw the money.

Relatives and friends could also add to the child’s JISA as a gift. They should not be worried about it because the parents or the child will not be able to get the money anyway, not until the child turns 18 years of age.

Downside: First and foremost, if the capital is invested in Stocks and shares in JISA, then the money in it is exposed to the risk of market volatility.

Also, the money in the JISA is entitled to the child. The disadvantage here is if the child chooses to spend all of the money on partying or good times. Parents will not be able to do anything about it because the money is solely for the child and no one else. That is why educating our children about financial literacy at a young age is crucial; it is for them to learn and appreciate saving, investing, and most of all, the value of money.

I’ll be posting my blog soon regarding ways that we can teach our children financial literacy.

Table Summary of the 5 ISAs

To Sum It Up

Having these kinds of non-taxable investment accounts is one of the greatest opportunities for residents of the UK. Taxes are indeed a burden, as they take a big chunk of our salary, but knowing that there are ways to avoid them is a blessing.

Everyone should take this opportunity to further boost their savings and investment returns. In the end, we should maximise all of the opportunities that are laid before us and learn how to handle each one of them. All of these have their own pros and cons; we just need to study and learn which one will propel us further and faster towards our own and our family’s goals.

There is no one perfect blueprint in this world to follow in order to be happy and content; there are only priorities that we have in our lives that will make us truly happy and fulfilled.

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.