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Home » Features » The top 10 myths about ISAs exposed

What you can achieve with an ISA can be really exciting, but the details of the small print of a tax wrapper aren’t anyone’s idea of a gripping read. Instead, most people get by with vague recollections, half-remembered rules, and what we hope are reasonable assumptions. Unfortunately, over the years, a combination of fading memory and rule changes means we can build up some misunderstandings about ISAs, which can stop us making the most of them.

Back in 1999, the ISA allowance was just £7,000, and once you’d picked cash or stocks and shares, there was no going back. Things look very different now, with a £20,000 allowance, and freedom to transfer. Given that so many of the most common ISA myths emerged back then, it’s important to revisit all the things we think we know about ISAs, so we can take full advantage of them.”

Cash ISAs

#1. I don’t pay tax on my savings anyway

Right now, 95% of people don’t, but that’s not the full story. The personal savings allowance means basic rate taxpayers don’t pay tax on the first £1,000 of interest and higher rate taxpayers don’t pay tax on the first £500. While savings interest is so disappointing, most people don’t run into these thresholds, so it’s easy to assume tax on savings isn’t something you need to worry about. The year after the personal savings allowance was introduced in 2016, over 1.5 million fewer cash ISAs were opened, and they still haven’t recovered.

However, if a pay rise pushes you into a higher tax bracket, your tax-free savings allowance drops – and then disappears. Meanwhile, over the years, your cash savings may well grow, and if rates rise or the savings allowance is cut, you could face tax on your savings out of the blue. Putting money in a cash ISA isn’t just about saving tax today, it’s about protecting your money from tax in the future too.

#2. The interest rates on cash ISAs are too low to bother with

Savings rates are still low, despite the rate rises we’ve seen in recent months, as banks aren’t in a hurry to pass better rates onto their savers. However, with more rises expected through the rest of the year, there’s a good chance we will see some more rewarding deals hitting the market.

Unfortunately, the best ISA rates are still slightly below their savings account equivalents. However, the difference is so fractional that once you start paying tax on savings, cash ISAs soon start offering better value.

#3. I can stick with savings accounts, and switch to an ISA when tax becomes an issue

If you’re a basic rate taxpayer and don’t have significant savings, you might think you’re better off building cash in savings accounts and switching it if tax ever becomes an issue. Unfortunately, by that stage, you have no way of knowing whether the ISA allowance will be generous enough to enable you to switch your savings.

Stocks & Shares ISAs

#4. I don’t pay tax on my investments anyway

You’ll pay tax this year if you make more than £12,300 in capital gains or over £2,000 in dividends outside an ISA. If you’re just starting out, you’d be forgiven for thinking that you have plenty of room within your allowances, but you’ll be surprised how quickly gains can add up over the years. This April’s 1.25 percentage point rise in dividend tax means that if you bust the limit, you will be punished even harder than usual. By investing within an ISA, you’ll protect this part of your portfolio from these taxes for life. The other big attraction is that putting investments into a stocks and shares ISA also protects you from the hell of ever having to include it on your tax return ever again.

Junior ISAs

#5. You shouldn’t take a risk with your child’s investments

69% of JISAs opened in the 2019/20 tax year were cash. An enormous part of this is that parents may think of stock market JISAs as risky, because they’ve seen share prices fall significantly at various times. Falls at the start of this year have hit the headlines, and may have helped convince more people that they’re better off in cash.

For some people this will be the right choice – if your children are older and need the money in the next few years, or if you absolutely need a specific sum by a particular date and there’s no alternative way to pay. For everyone else, however, investments are worth considering. While the value of your investments will rise and fall in the short term, a JISA is for the long term of up to 18 years, when they usually have time to ride this out and take advantage of long-term growth.

Lifetime ISAs

#6. I’m not planning to buy property right now – so I don’t need one

There are two different time limits that mean you should open a LISA as early as possible. Over the short term, you need to have had it open for 12 months before you buy a property. Over the long term, once you hit 40, you can’t open a LISA. Getting started now will protect your right to a LISA.

#7. I already have a house, so I don’t need a LISA

A Lifetime ISA is a great way to save for a first property, but it can also be a brilliant way to save for retirement. If you’re employed, your pension should be the first port of call, because your contributions will trigger payments from your employer. However, once you have taken full advantage of all the contributions they’re willing to pay, you can consider paying into your LISA.

The 25% bonus on contributions has the same impact as 20% tax relief, which means basic rate taxpayers get the same benefit when they’re paying in. The tax relief is the same as you go along too, but the income from a LISA is all tax free, whereas some of the income from your pension may be taxed. It means that for a basic rate taxpayer who will pay tax in retirement, it’s worth considering for the next chunk of your retirement savings. For self-employed people, who don’t get the advantage of employer contributions, it’s worth considering from the outset.

Planning

#8. Stock markets are a bit too volatile. I’ll wait and see

There’s no denying that stock markets have been incredibly volatile recently, but the problem with this approach is that you won’t know the moment it makes most sense to invest until it has already passed, and then you’ll have missed out on the growth in the interim. You can remove the timing risk by opening a stocks and shares ISA now and holding cash. Then over time you can drip-feed your money into investments. Alternatively, you can set up a direct debit to pay into an ISA throughout the tax year, and spread your risk that way.

Making a move

#9. My money is tied up in an ISA

Stocks and shares ISAs are long term investments, but that doesn’t mean you can’t access it if your plans change. Likewise, a cash ISA, unless it’s fixed for a term or has a notice period, can be accessed at any time.

#10. Once I’ve opened an ISA, I’m stuck with it

Since 2014, you’ve not only been able to switch providers, you’ve also been able to switch between cash and stocks and shares ISAs (and back again). You can switch previous years’ ISAs without affecting this year’s allowance, and consolidate your ISAs with one provider to make it easier to manage. Just check your new provider accepts transfers in.

Related

Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Stuart Fieldhouse

Stuart Fieldhouse

Stuart Fieldhouse has spent 25 years in journalism and marketing, including as a wealth management editor for the Financial Times group, covering capital markets and international private banking, and as an investment banking correspondent for Euromoney in Hong Kong. He was the founder editor of The Hedge Fund Journal.

Stuart has worked at CMC Markets, supporting the re-launch of its global financial spread betting and CFD trading platforms. He is also the author of two books on trading, published by Financial Times Pearson. Based in The Armchair Trader’s London office, Stuart continues to advise fund managers, private banks, family offices and other financial institutions.

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