The Individual Savings Account (ISA) is one of the most tax-efficient wrappers available to savers and investors. And with a generous annual allowance to subscribe, it’s unsurprising that most are often in a rush to contribute to an ISA each tax year in order to begin maximising their returns.
But as there are now four main Adult ISA products to choose from – as well as the Junior ISA – it’s important to understand which is the best for your capital, and to ensure you’re following all of the ISA rules when saving or investing.
Whilst it’s always recommended to take independent financial advice before making any form of investment, to make sure you’re on the right track, answering these four questions is a great place to start.
1. Which ISA is right for you?
One of the most important considerations is which ISA is the right one – or ones – for you and your portfolio.
The variety of ISA types mean there is an option for almost everyone. For example, for cautious savers who need the reassurance of Financial Services Compensation Scheme (FSCS) protection and would like to be confident that their capital is not at risk, the Cash ISA (or Cash Lifetime ISA) will be the most appropriate option.
This is because the other two main Adult ISA products – the Innovative Finance ISA (IFISA) and Stocks and Shares ISA – are investment accounts which results in returns not being guaranteed and capital being at risk.
But the Cash ISA has been offering low interest rates for some time, and these have lowered even further in response to the Coronavirus pandemic. Therefore, experienced investors willing and able to take on more risk could consider adding the IFISA or Stocks and Shares ISA (or both for increased diversification) to their ISA portfolio.
The IFISA offers potential returns of between 4% and 8% and IFISA investments are usually for a fixed-term of between two and four years – so it’s crucial that you’re certain you won’t need access to the funds invested before the end of the agreed period.
The Stocks and Shares ISA offers potential returns in excess of 4%, but the stock market is volatile in nature and fluctuations should be expected. Because of this, the Stocks and Shares ISA is considered a long-term investment option, and capital should be invested for a minimum of five years in order to allow time for any falls in value to recover.
2. Which ISA types have you already subscribed to this tax year?
It is possible to split the annual ISA allowance, meaning you aren’t limited to subscribing to just one ISA each tax year.
But there are rules surrounding this that you must be aware of – and one of those is that you can only subscribe to one of each type of ISA per year.
As a result, before making an ISA investment, it’s imperative you consider which ISA accounts you have already contributed to. For example, if a saver subscribed £10,000 to a Cash ISA in April 2021 after the annual ISA allowance had reset, they could not subscribe to another Cash ISA until the 2022/23 tax year begins on 6th April 2022.
However, if the saver had found a better Cash ISA rate with a different provider and did not want to wait until 2022 to subscribe, an ISA transfer could be used – allowing the saver to move funds from one Cash ISA to another without affecting the annual ISA allowance or breaking any ISA rules.
3. How much of the annual ISA allowance have you used?
When splitting the annual ISA allowance – which is an invaluable tool for portfolio diversification – it’s crucial to ensure the limit, which is £20,000 in 2021/22, is not exceeded. If it is, all funds over the allowed amount will lose their tax-free status and penalties could be incurred.
Therefore, it’s important to keep track of how much you have subscribed. It’s your responsibility to do this, and if you think you have oversubscribed at any point, you should contact your ISA provider immediately.
But remember, there is no limit to the number of ISA accounts you can accumulate over the years. So whilst you must not exceed £20,000 in one tax year, you’re able to contribute more to an ISA of your choosing as soon as the allowance resets.
4. Have you carried out research into the provider’s credibility?
The importance of this depends on the ISA you have decided to invest into. For the most part, the Cash ISA is offered by mainstream, Financial Conduct Authority (FCA) authorised banks and is protected by the FSCS.
But for experienced investors looking to take on more risk with the likes of an IFISA, researching the track-record of a provider and ensuring they have the knowledge and expertise to be offering investment into the asset is key.
Take time to understand the provider’s risk mitigation processes, as well as their processes for screening and originating lending opportunities.
Ask to see case studies (where applicable) of previous opportunities and speak to the team via phone call as well as reading their brochures and offer documents.
When looking at a Stocks and Shares ISA, remember it often doesn’t allow for the same amount of visibility over investment specifics as the IFISA – but conducting due diligence is still necessary.
Where possible, look into the team behind the shares of the company you’re looking to buy or the managers of the funds you’re investing into. What this encompasses will range widely, but for funds in particular, considering the historical data that is available is always a strong starting point. Whilst past performance isn’t an indication of future success, it can provide a level of insight that allows you to start gauging whether it’s the right option for your portfolio.
There are no guarantees with investment products, but being able to trust the expertise of the provider and understand how returns are generated is an important factor when deciding whether an investment is the right one for you.
Making an ISA investment
Making the most of the ISA and its annual allowance is key when looking to maximise returns. With £20,000 available to subscribe and the ability to hold as many accounts as you wish, there are almost endless opportunities to save and invest in a tax-efficient manner.
And as long as you’re asking yourself the right questions – and taking advice from independent financial professionals – before making any decisions, you could be on the road to targeting high, tax-free potential returns.