If you’re thinking of saving or investing, make sure you don’t pay more tax than you need to. ISAs can help you make the most of your money.
Are ISAs tax free?
Most of your income, such as your salary, savings interest and investment profits, are subject to tax. That’s not the case with ISAs. All the money you earn on savings and investments held within the ISA ‘wrapper’ is completely tax free.
Tax advantages for cash ISAs
A cash ISA is a type of savings account where the interest you earn is never taxed. Because of the tax benefits, there is a limit to how much you can contribute annually. For the tax year 2018/19 – which runs from April to April – this stands at £20,000. If you have children, a further £4,260 for each child can be added through Junior ISAs.
You’re allowed to have multiple ISAs, but you can only open one cash ISA in any one tax year.
Any interest you earn on an ISA doesn't count towards your personal savings allowance. If you’re a basic rate taxpayer, you can now earn up to £1,000 of interest on any savings account without having to pay tax on it. Higher rate taxpayers can earn up to £500, but additional rate taxpayers get no allowance at all. So, if you’re someone who earns a lot of interest on your savings, you can protect more of it in an ISA.
Tax advantages for stocks and shares ISAs
With a stocks and shares ISA, you can invest in the stock market through funds, shares and bonds. Normally when you make money from your investments, you will be subject to tax. But investments held within an ISA wrapper are tax-efficient, so if you build up your portfolio over time, the tax breaks can be very lucrative.
- Capital gains tax: With most investment products, you have to pay capital gains tax if the amount of earnings in a single year exceeds the set limit, currently £11,700. Profits from shares held in an ISA are not subject to capital gains tax, so any growth on your investment is all yours to keep. You cannot use losses made on your investments in your stocks and shares ISA to offset capital gains on your other investments.
- Tax on interest: Some investments, such as government and corporate bonds, pay interest. These are also shielded from the taxman if held within an ISA. Utilising the tax-free status of bonds can be an effective way to generate capital growth.
- Dividend tax: Income from a stocks and shares ISA that is paid as a dividend is now completely tax-free. Previously, dividends would be paid with 10% deducted at source even for investments held within the ISA wrapper, but that rule was scrapped from April 2016.
If you invest in shares or funds that aren’t in an ISA, you can also earn up to £2,000 in income without paying tax on it. Dividends above this amount are taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. Dividends received for shares within an ISA will remain tax free and won’t affect your overall dividend allowance.
Do you need to declare ISAs on your tax return?
If you fill out a self-assessment form each year, you don't need to declare any income or capital gains from an ISA to HMRC.