Are you making the most of your annual ISA allowance?

Optimise your ISA allowance by 5 April 2024! Nick Daws explores ISA choices—Cash, Stocks, Innovative Finance, and Lifetime ISAs—for potential tax savings

In just a few weeks (5th April 2024) it will be the end of the financial year. And that means if you want to make the most of your 2023/24 ISA allowance, you need to take action soon.

As you may know, ISA stands for Individual Savings Account. ISAs are saving and investment products where you aren’t taxed on the interest you earn or any dividends you receive or capital gains you make. An ISA is basically a tax-free ‘wrapper’ that can be applied to a huge range of financial products.

With ISAs you don’t get any extra contribution from the government in the form of tax relief as you do with pensions. But – except in the case of Lifetime ISAs – you can withdraw your money at any time (subject to any rules set by the provider about the term and notice period required) and you won’t be taxed on it.

Everyone has an annual ISA allowance, which is the maximum you can invest in ISAs in the year concerned. In the current financial year (2023/24) this is a relatively generous £20,000.

There are currently four main adult ISA categories: Cash ISA, Stocks and Shares ISA, Innovative Finance ISA (IFISA) and Lifetime ISA (LISA).

You can divide your £20,000 ISA allowance among these in any way you choose, though the most you can invest in a Lifetime ISA in a year is £4,000. Note also that you are currently only allowed to invest in one ISA in each category per year (although this will change from 2024/25).

Let’s look at each ISA type in a bit more detail…

Cash ISA

Cash ISAs are like standard savings accounts, except the interest you receive doesn’t incur tax.

In the last few years cash ISAs declined significantly in popularity. That was partly due to the very low rates of interest many were paying (often below the rates paid on ordinary non-ISA savings accounts).

In addition the Personal Savings Allowance (PSA), introduced in 2016, meant that basic-rate taxpayers could earn up to £1,000 in savings interest every year without paying tax anyway. 

• Higher-rate (40%) taxpayers earning over £50,270 get a reduced £500 tax-free PSA while additional-rate (45%) taxpayers earning over £125,140 a year get no PSA at all. 

While interest rates were very low, most people didn’t have to pay any tax on their savings interest. So for most there was no real incentive to open a cash ISA.

In the last year or so things have changed, however. Interest rates on savings accounts have been rising steadily, and at the time of writing the best (both ISA and non-ISA) are around 5%. That means basic rate taxpayers now only need around £20,000 in ordinary savings to have to start paying tax on the interest, and higher-rate taxpayers around £10,000.

Clearly if you have to start paying tax on your savings interest, a Cash ISA suddenly looks a lot more attractive. That applies especially if you’re a higher or additional rate taxpayer, as the interest on your savings will be taxed at your highest marginal rate.

In addition, money invested in a cash ISA remains tax-free year after year. So interest paid on your interest will be tax-free in future years as well.

For all these reasons, if you’re likely to exceed your personal savings allowance (or don’t have one) there is a good case for using at least some of your annual ISA allowance on a cash ISA.

Stocks and Shares ISA

Stocks and shares ISAs are a good choice for many people saving long term.

Over a longer period the stock market has outperformed bank savings accounts, often by a considerable margin. You do, though, have to expect some ups and downs in the value of your investments in the short to medium term.

You can opt for a standard stocks and shares ISA offered by a wide range of financial institutions and let them choose investments for you. Alternatively you can use self-investment platforms such as BestInvest and Hargreaves Lansdown to pick your own investments from the wide range of shares and funds available.

In recent years I have invested much of my own annual ISA allowance in a stocks and shares ISA with Nutmeg, a robo-manager platform that has produced good returns for me. You can read my in-depth review and article about Nutmeg on my Pounds and Sense blog if you like..

Innovative Finance ISA

IFISAs are on offer from a growing range of peer-to-peer (P2P) lending platforms. 

P2P platforms allow people to lend money to businesses and private individuals and get their money back with interest as the loans are repaid. If you invest in the form of an IFISA all the interest you receive from P2P lending is paid tax-free, otherwise it’s taxed as income (though interest from P2P lending does qualify for the PSA of up to £1,000 a year, mentioned above).

Peer-to-peer platforms generally offer more attractive interest rates than bank and building society accounts – from around 5% to 10% or more. They aren’t covered by the same guarantees as the banks and are therefore riskier, though. And if you need your money back urgently there may be delays and/or extra charges to pay.

Nonetheless, in the current climate of stock market volatility, growing numbers of people are looking to IFISAs as a home for at least some of their savings/investments.

One such option I have used myself is Kuflink, a P2P property investment platform. They offer an IFISA with automatic diversification over a 1, 3 or 5 year term (you can also choose your own self-select loans within an IFISA wrapper). You can read my full Pounds and Sense blog review of Kuflink here.

Another IFISA option (which I am using myself this year) is Assetz Exchange. They prioritize lower-risk property investments such as supported housing for people with disabilities, which you can invest in through a self-select IFISA. You can read my full blog review of Assetz Exchange here.

Lifetime ISA

Lifetime ISAs or LISAs are intended to encourage younger people to save. You have to be under the age of 40 – though over 18 – to open one.

LISAs are designed for two specific purposes: buying your first home and saving for retirement. How they work is that you can pay in up to £4,000 a year (lump sums or regular contributions) and the government will top this up with another 25%. As long as you open your LISA before the age of 40 you will continue to receive the bonuses on your contributions until you reach 50.

So if you pay in the maximum £4,000 in a year, the government will top this up to £5,000. If you pay in the full £4,000 every year from the age of 18 to the upper limit of 50, you will therefore get a maximum possible bonus from the government of £32,000. That is in addition to any growth in the value of the investment itself, of course.

LISAs are somewhat different from the other types of ISA mentioned above, but nonetheless any money you invest in one comes out of your annual ISA allowance, currently £20,000. So if you pay the maximum £4,000 into a LISA this year, that comes out of your £20,000 ISA allowance, leaving you with ‘just’ £16,000 to invest in other sorts of ISA.

Your money will grow without any tax deductions in a LISA, and you can also withdraw without having to pay tax. However, there are certain restrictions. In particular, you can only use the money in your LISA for one of two purposes: paying a deposit on your first home or saving for retirement.

While you can access your money for other reasons, you will then lose 25% of the total, including your own contribution and the government bonus along with any investment growth. That means you may get back less money than you put in.

Closing thoughts

As mentioned above, the 2023/24 ISA allowance is £20,000 and offers the potential to save a lot of money on tax, assuming you are lucky enough to have this amount to save or invest. But, very importantly, it cannot be rolled over. 

So if you don’t use your 2023/24 ISA allowance by 5th April 2024 at the latest, it will be gone forever. It is therefore vital to attend to this now and ensure you get as much benefit as possible from this valuable tax-saving concession.

As always, if you have any comments about this article, please do leave them below.

Disclaimer: I am not a professional financial adviser and cannot give personal financial advice. You should do your own ‘due diligence’ before making any investment, and seek professional advice from a qualified financial adviser if in any doubt how best to proceed. All investments carry a risk of loss.

Nick Daws writes for Pounds and Sense, a UK personal finance blog aimed especially (though not exclusively) at over-fifties.

Photo credits: Pexels