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Individual Savings Account (ISA) offer tax-free interest payments and could be a great way to let your hard-earned money work for you, especially in these uncertain times.
Each tax year, customers get an ISA allowance. In the 2020/2021 tax year this is £20,000 ($27,800). They can choose to split this between stocks & shares ISAs, cash ISAs, and Lifetime ISAs, among others.
However, there are some myths and misconceptions around the financial product.
Sarah Coles, personal finance analyst, Hargreaves Lansdown, noted that ISAs have “grown up over the years… there’s a risk that our overall impression of ISAs now varies significantly from reality.”
She explained that in 1999, interest rates were over 5%, the ISA allowance was just £7,000, and once you’d picked cash or stocks and shares, there was no going back.
“Given that so many of the most common ISA myths emerged back then, it’s important to revisit our understanding of ISAs. We need to be sure we’re not making the same assumptions and the same mistakes each year, so we can take advantage of the opportunities ISAs offer.”
Here are common myths broken down and explained.
1. I don’t need a cash ISA because I don't pay tax on my savings anyway
The year after the personal savings allowance was introduced in 2016, over 1.5 million fewer cash ISAs were opened. Savers decided that because the first £1,000 of interest is tax free for basic rate taxpayers, they didn’t need to bother.
But 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, according to Hargreaves Lansdown.
If a pay rise pushes you into a higher tax bracket, your tax-free savings allowance will drop to £500 for higher rate taxpayers and disappear altogether when you become an additional rate taxpayer.
If rates rise or the savings allowance is cut, you could face tax on your savings far sooner, so an ISA is the only way to protect your savings from tax, for life.
2. The interest rates on cash ISAs are too low to bother with
Typically the best rates are slightly below their savings account equivalents, but at the moment you can get a better rate on an easy access ISA than on a savings account.
Fixed savings rates are still fractionally higher than their matching cash ISA, but the difference is so small that once you start paying tax on savings, cash ISAs soon start offering better value.
3. I can 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.
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 £2,000 in dividends outside an ISA. If you’re just starting out, you may think you’ve got plenty of room within your allowances, but you’ll be surprised how quickly gains can add up over the years.
The other advantage is that putting investments into a stocks and shares ISA protects you from "the hell of ever having to include it on your tax return ever again," said Hargreaves Lansdown.
5. You shouldn’t take a risk with your child’s investments
Some parents think of stock market Junior ISAs (JISAs) as risky, because they’ve seen share prices fall significantly at various times. It’s why 70% of JISAs are in cash.
However, 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.
6. I’m not planning to buy property for a while – so I don’t need one
There are two time limits that mean you should open a Lifetime ISA (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. Stock markets are a bit too volatile, I’ll wait and see
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.
8. I already have an ISA so I don’t need to worry about it
Even if you don’t have anything more to put into an ISA this year, the end of the tax year is a useful prompt to take stock. Check your investments are performing as you expect – and if not, why not.
Also check the interest rate you’re earning on your cash ISAs and whether you could earn more by switching.
Hargreaves Lansdown research shows one in three people have never switched a cash ISA and 43% have no idea what interest they’re earning.
9. My money gets 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, with a cash ISA, unless it’s fixed for a term or has a notice period, it 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.
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