UK tax wrappers

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UK tax wrappers

Understanding ISAs

How to pick between the different types of ISAs

This guide contains tips on reducing the amount of tax you have to pay on your investments. Because tax rules change from country to country, this learning guide is aimed specifically at British Wealthyhood readers.

Even in this case, tax treatment depends on your individual circumstances and may be subject to change in the future, so you may want to consult your accountant. 🤓


Getting started with tax wrappers

Whether you’re keeping your savings in cash, or investing in things like stocks and bonds, your returns can be liable for tax. To reduce the amount of tax you have to pay, one option is a tax wrapper.

The most common form of tax wrapper in the UK is an Individual Savings Account (or ISA). Any money you make from savings or investments contained within an ISA is tax-free. You’re allowed to invest up to £20,000 each year and, depending on your goals, there are several to choose from.

You can even spread your money across several different kinds of ISA, as long as you don’t deposit more than the £20,000 limit in any one tax year.


Cash ISA

First up are cash 💰 ISAs. These are the simplest type of tax-free accounts. They’re literally just cash savings accounts, but you don’t have to pay tax on the income you earn from interest.

You can choose to be able to withdraw your money at will, or lock up your savings for a fixed length of time. In return for the lock-up, your bank will normally reward you with a slightly higher interest rate.


Stocks & Shares ISA

Then there are stocks and shares 📈 ISAs. A stocks and shares ISA is just like an investment account you would have with a broker or fund manager, but, once again, any returns you get are tax-free.


Innovative Finance ISA

Finally, there’s the innovative finance ISA, which offers tax protection for peer-to-peer lending (or P2P lending). P2P is kind of like the Tinder of investing: it matches people wanting to borrow with those wanting to lend out their cash.

Returns are generally higher than those you’d get from a Cash ISA, but the risk involved is higher too. As far as ISAs are concerned, innovative finance ISAs ensure you pay no further tax on your on your P2P returns.


Lifetime ISA

Those are the three broad categories of ISA, but to confuse things further, there are also a couple of special categories for people at different stages of their life. If you’re under 40 and looking to save for the long term, or maybe for that first house, a Lifetime ISA may be your thing.

They offer free money. Like, actually free money. The government pays a 25% bonus on the amount you put in each year. Although it’s worth noting that you’re only allowed to put £4,000 of your annual £20,000 allowance towards this type of account each year – so your government bonus is capped at £1,000 per year.

But what the government gives, the government takes away. You have two options with your Lifetime ISA: either keep the money in it until you’re 60, or use it to buy your first home. If you take the money out before you’re 60 for any other reason, you lose the government bonus. 😓


Junior ISA

Last but not least, there’s the Junior ISA. This allows you to save money on your children’s 👶🏼 behalf. There’s an annual investment limit of £9,000, but that’s in addition to your own allowance.

A word of caution on the ISA: use it or lose it! Your annual ISA allowance can’t be carried over to the following tax year, so if you don’t use part of it, it’ll disappear when your allowance resets each April. And because ISAs are tax-efficient, a general rule of thumb is to use your ISA allowance before investing in non-tax-efficient wrappers. If you’ve got money left over you may then wish to look elsewhere.


The takeaway

ISAs let you invest in stocks, ETFs or cash, and a Lifetime ISA offers a bonus from the government that you can use when you buy your first home or retire.

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Keep in mind that when you invest, your capital is at risk and this learning guide is for information only and is not investment advice.

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