The main benefit of using an ISA to save or invest is simple – all returns are free from income and capital gains tax. But as the new tax year approaches, it’s crucial to understand the key ISA rules so you can maximise potential returns.
You can have as many ISAs as you want, but can only open one of each kind per tax year
To aid in building a well-balanced, diversified portfolio, holding a number of ISAs is an important consideration. And the good news is that, in theory, you can have as many ISAs as you want.
However, there are some intricacies surrounding this. An important rule – and one that could affect your tax-free returns should it not be followed – is that in a single tax year, you can open a maximum of four separate ISAs. This is because you can only open and contribute to one of each type of ISA per tax year.
As an example, an experienced investor with the appropriate risk appetite could open one Cash ISA, one Stocks and Shares ISA, one Innovative Finance ISA (IFISA) and one Lifetime ISA in the 2021/22 tax year. This is possible because you can split the annual ISA allowance across ISAs (more on this later).
Therefore technically, an investor could open one of each type of ISA every year, allowing them to achieve a very strong level of portfolio diversification all within the ISA wrapper.
All ISA contributions must not exceed the annual ISA allowance
The annual ISA allowance is £20,000 at-present, allowing ISA savers and investors to subscribe up to this generous amount to an ISA product – or several ISA products – of their choosing each tax year.
Any contributions made in excess of the annual ISA allowance will not be tax-free, and a penalty may be incurred, depending on your provider.
The ISA allowance is subject to change, though it has remained at £20,000 since 2017/18, when it increased from £15,240. And whilst the allowance is the maximum you are able to contribute to an ISA per year, each ISA may also have their own subscription limit.
Of the Adult ISAs, the Cash ISA, Stocks and Shares ISA and IFISA all have subscription limits of £20,000 – matching the annual ISA allowance. However, the Lifetime ISAs subscription limit is significantly less, sitting at just £4,000, though this is arguably because the rules are slightly different for the Lifetime ISA, given the government will provide an additional 25% each year.
You can split your annual ISA allowance between multiple ISAs
As mentioned above, it is possible to open multiple ISAs per tax year, meaning you can choose to split your annual ISA allowance between several ISAs.
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As long as the £20,000 ISA allowance is not exceeded, savers and investors can build a diversified ISA portfolio by splitting their allowance across ISAs in any weighting they feel is appropriate for their investment goals.
For example, a cautious saver may choose to subscribe £15,000 to an easy-access Cash ISA and £5,000 to a Cash Lifetime ISA with the intention of saving for retirement.
On the other hand, an experienced investor could subscribe £5,000 to a Cash ISA, £5,000 to a Stocks and Shares ISA and £10,000 to an IFISA as they are willing and able to take more risks in the search for higher returns.
It is possible to transfer an ISA without contributing to the annual ISA allowance
Whilst some experienced investors may feel limited by the £20,000 annual ISA allowance, there is actually a way to save or invest what could be considerably more than your ISA allowance each tax year.
Achieved by utilising ISA transfers, when transferring an ISA, there is an official process that must be followed – and when it is, funds being transferred never leave the ISA tax wrapper, meaning they do not deduct from your current ISA allowance even though they are being subscribed to a different ISA.
Remember: withdrawing and reinvesting funds from an ISA manually causes them to lose their tax-free status. To initiate an ISA transfer following the correct process, contact your provider.
There are rules regarding how much you can transfer from one ISA to another
Though ISA transfers are not governed by the annual ISA allowance, meaning you can transfer as much as you wish, there are certain rules surrounding the amount that can be transferred in specific circumstances.
If you want to transfer money invested into an ISA during the current tax year, you must transfer all of it. For example, an experienced investor who invested their full £20,000 allowance into a Stocks and Shares ISA at the beginning of the tax year but decided to open an IFISA one month later and transfer funds over would be required to transfer all £20,000.
However, if you want to transfer money invested into an ISA in a previous year, you can choose to transfer all or only part of it. This means an experienced investor with £50,000 sitting in a Stocks and Shares ISA from previous tax years could choose to transfer just £30,000 of this to an IFISA – it is not necessary to transfer it in full unless you wish to do so.
Understanding the key ISA rules to help make the most of your ISA investments
Once the key rules and considerations surrounding the annual ISA allowance, ISA transfers and how many ISAs you can have are fully understood, it can provide a level of confidence that you are using your ISAs to their full potential each year.
With the ability to open several ISA types per tax year – allowing you to build a diversified portfolio which meets your personal investment needs whilst benefiting from a generous tax-free allowance - an ISA can be an important consideration for any experienced investor looking to maximise potential returns.
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