A watering can held above a sprout growing from a pile of money symbolising how money can grow if invested in a stocks and shares ISA

Written by 9:46 am Investing

The ikigai guide to ISAs

About 10 minutes to read

There are lots of different ways to save, but it’s generally accepted that an ISA – aka an individual savings account – may be one of the best and simplest tools in the savings arsenal.  

All of us have financial goals, ranging from smaller aims like nice dinners out or holidays, to larger ambitions to do with bigger purchases and our overall lifestyle. When we’re saving, we’re doing so because there are things we want to achieve. And yet it can be hard to know what’s best for our money to help it grow. 

Given that so many of us have goals around our money – and with the last year meaning we have, on average, saved more than ever before – ISAs offer a way to make more of what we’ve earnt.

When I think about my own finances, for example, I’ve always been good at saving but even until quite recently, I was still putting money aside by moving it into a second current account that I didn’t touch. The set up was helpful (to an extent) because it helped me budget and was a very easy place to keep money I wanted to be able to access in an emergency. It helped me feel in control, because I always knew I could dip into those savings, which I thought I wouldn’t be able to do if I locked the money up in a typical savings product. 

But it wasn’t very tax-efficient, was definitely exposed to inflation, and it’s frustrating to think how much earlier I could have started and how interest or gains could have compounded over that time.

Fact is, with the rise of new apps, there are now more ways to save into accounts that are easier than ever to set up, manage, and of course access in case of emergencies. This includes the mighty ISA – which, as you may have heard, ikigai now offers as well. 

With the launch of ikigai’s Stocks and Shares ISA, we felt there was no time like the present to share our very own guide to ISAs. This will walk you through:

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What is an ISA? 

ISA stands for “Individual Savings Account” and anyone in the UK can benefit from them. In a nutshell, they offer the freedom to save or invest without paying tax on any interest you earn, plus, they’re pretty easy to understand, increasingly flexible, and require less maintenance than some other financial products. 

What are the different kinds of ISA? 

Whether you’re thinking about investing or a better way to save, ISAs offer the means to do both. There are three primary types of ISA – explained below – each with their own benefits and limitations. There are also Junior ISAs for people under-18 and Innovative Finance ISAs for those interested in peer-to-peer or crowdfunding opportunities. 

Cash ISA

These are the simplest and traditionally the most popular type of ISA. They’re essentially low risk saving accounts, except there’s no income tax on what you earn via interest. It’s a stable way to save and you can choose whether to open a fixed or variable rate cash ISA (which pretty much just determines how long your money is held in the ISA before you can start withdrawing it). 

Saying that, though it’s simple, the current climate and low interest rates could mean that your savings don’t grow much in a cash ISA (and inflation could even mean your savings reduce in value over time). 

Lifetime ISA

The Lifetime ISA (LISA) is probably most familiar to those looking to get on the property ladder, as it’s somewhat taken over from the Help to Buy ISA. A LISA gives you a government bonus of 25% on the money you put in, up to a maximum of £1000 a year – which is fab for young savers or for older people looking for a retirement income in the future. However, it’s worth noting that a LISA has a withdrawal charge (25% of the amount withdrawn) if you decide to take out the money for anything other than a first home or before you’re 60. 

Stocks and Shares ISA

By putting your money into a Stocks and Shares ISA, you’re investing your money. You’re buying shares, funds, ETFs, government or corporate bonds and other investment types via your chosen ISA. Depending on whether you go for a fully managed portfolio or a more active approach (where you choose the stocks and shares yourself), this kind of ISA may involve more or less input from you. 

A nice metaphor from the Times Money Mentor is that a Stocks and Shares ISA is like a hiking rucksack, writing “[This ISA] is big and strong and able to withstand all manner of taxes that HMRC unleashes on investors. There are also lots of compartments: one for your FTSE 100 shares, another for bonds, one for property funds, and so on. Investing is a bit like hiking: there will be highs and lows, just like the risks and rewards you experience as an investor.” 

Of course, because a Stocks and Shares ISA is an investment product, you will need to take a view on how long it’ll be before you want to access that money. To see the best growth, most experts recommend putting your money into investments for three to five years at the minimum. The benefit is that it gives your money the best chance to earn better returns. Plus, the money is free from capital gains and income tax.

You need to be at least 18 years old to open a Stocks and Shares ISA. 

Tax treatment depends on the individual circumstances of each client and may be subject to change in future.

Can you explain a little bit more about this tax stuff?

“The main benefit to having an ISA is tax-free investing,” says Edgar de Picciotto, co-founder of ikigai. “It really is that simple. You get a certain tax-free allowance each year and so every year, why not take advantage of that as much as possible?”*

Very simply put, in each new tax year you’re able to contribute up to a certain amount into an ISA without paying tax on either the interest or gains made through those savings. 

For the current 2021-22 tax year, which runs from 6 April 2021 to 5 April 2022, for example, this means you can place up to £20,000 into a Cash or Stocks and Shares ISA and the interest or gains will be tax free. This is the same as 2020-21. For a LISA, however, the total is capped at £4,000 per tax year. 

ISAs are tax efficient because unlike a typical savings account, where most people hand over 20% of the return on their savings to the taxman (and 40% for higher earners), savers don’t pay this tax on any growth, dividends or interest made within your ISA. Given that outside an ISA you can only earn £2000 a year in dividends tax-free, this is pretty good going! 

Generally, the earlier you start investing into an ISA each tax year, the more likely you are to see tax-free interest. But, as Edgar warns, “Your ISA resets every year. So if you don’t use it one year, you don’t get that allowance back. It really does make sense to try and max out your ISA every year on.”

In other words, if you don’t use it, you lose it. Planning ahead is therefore a good policy, ensuring you get the most out of your ISA limit before each end-of-year deadline.

*Tax treatment depends on the individual circumstances of each client and may be subject to change in future.

What happens if I go over my ISA allowance?

One of the easiest mistakes with an ISA is to go over your tax-free allowance. 

As mentioned earlier, the amount you’re allowed to put into an individual ISA is capped within each tax year – ie. for the current 2021/22 tax year, the overall ISA allowance is £20,000. But it doesn’t include what you’ve already put in – so if you entered the tax year with £12,000, you could still add a further £20,000 (if desired). Likewise, if you added the full £20,000 into an ISA that grew in value thanks to investment returns, then that growth wouldn’t count towards the allowance. It’s a really good way to grow a significant savings pot over time. 

Crucially, you can only contribute a total of £20,000 across all the ISAs you open in the same year. So, if you opened a LISA, where the max contribution per year is £4000 this year, you can then only contribute a maximum of £16,000 to your Stocks and Shares ISA in the same tax year.

“Do your research well,” says Edgar. “Because you can only open one ISA per year, you want to do your research and make sure you’re choosing the right one for you. Some platforms, even trading platforms, will offer ISAs where you have to select your assets. Whereas with digital wealth managers like ikigai, you don’t have to do that work on the assets yourself. Also look at the fees you’ll get before investing.” 

If you think you have exceeded the annual ISA limit you should contact your ISA provider as soon as possible. You should also contact HM Revenue & Customs (HMRC) using the ISA helpline on 0300 200 3312 and flag that you have exceeded the limit. You won’t be entitled to any tax relief on any excess payments, and you could also be liable to a penalty, so it’s important to handle it as soon as you can. 

What are the main benefits to opening a Stocks and Shares ISA? 

A Stocks and Shares ISA is sometimes called an ‘investment’ or ‘equity’ ISA. At its core, this kind of ISA is really a form of investment account.  

“In the end, it’s about what you’re ready to invest or even what you’re ready to put your money in. If you’re asking about why Stock and Shares versus a Cash or Lifetime ISA, it’s really the same question as ‘what should I do with my money?’” explains Edgar. “It’s a question of saving versus investing versus pensions.” 

Of course, there are some clear and tangible benefits for people who are interested in investing, with the biggest being the tax advantages – especially if you’re a higher or additional rate taxpayer. 

Why? Because you don’t pay dividend or capital gains tax on returns made within an ISA. This is great if you exceed the £12,300 annual Capital Gains allowance or the £2000 dividend allowance. It’s a great opportunity for long-term savers who want to benefit from compounding returns over time but also benefit from a tax-free wrapper.

The average Stocks and Shares ISA has also historically generated around 6 – 7% annual return. In today’s economic climate where interest rates are very low, this would help you avoid losing money on your savings through inflation (no mean feat!), although there are no guarantees that investments will keep going up.

Edgar adds, “Given that we’re in a low interest rate environment right now, if you have the capacity to take on the risks of investing then it might make sense for you. This is especially true if you’re in a strong financial position with an emergency fund (of typically three to six months in savings).”  

But are there risks in having a Stocks and Shares ISA?

At the end of the day, opening a Stocks and Shares ISA is a form of investing. This means that whilst any gains would be tax free, there is also the risk that your ISA could lose money. If you’re not comfortable taking risk then a cash or lifetime cash ISA may be a better option for you. 

“It can be helpful to approach your money using the waterfall method,” says Edgar. “First you pay off your high interest debt, then build out your emergency fund, then look at what opportunities exist in the investing space. There might be other steps in between for you personally, but the major steps are about placing yourself in a strong position, bolstering your resilience, so you can take on risk and make your money grow.”   

It’s important to recognise that there’s simply no such thing as the best stocks and shares investment – not even in ISA form. Yes, it’s true that, historically, stocks and shares have outperformed money in savings accounts – but there’s no guarantee that they’ll keep doing so in future. 

So always remember, investments can go down as well as up. That’s why it’s so important to make sure you’ve diversified your portfolio to mitigate your exposure to risk and that you’re prepared to ride out the bumps in the market. 

Can you have more than one stocks and shares ISA? 

You can have multiple ISAs, but you can only open one ISA of each type per year. This means you could open a new Stocks and Shares ISA as well as a Lifetime or Cash ISA this year, but you can’t open two Cash ISAs or two Stocks and Shares ISAs in the same tax year.

How do you know if a Stocks and Shares ISA is the right kind for you? 

Like with any kind of investing or saving, we can’t tell you what’s the right product for you but we can give you suggestions on how to make the choices for you, your lifestyle, and your goals. 

“ISAs can help you grow your money faster than general investment accounts in some instances thanks to the tax-free allowance,” says Edgar*. “It can impact the speed by which you reach your goals because it impacts the way your money is compounding. Just think, the direct effect of taxes might be small but over time and in the context of compounding, if you think that’s money you could have seen compounding over the ten years that you plan to invest your money, it adds up to a lot.” 

*Tax treatment depends on the individual circumstances of each client and may be subject to change in future.

Before putting money into an ISA, you therefore should always think about how soon you expect to need the money that you’re contributing. For example, if you’re saving for a house and expect to make a purchase in six months, then putting your money into a Stocks and Shares ISA might not be the right course of action for you right now. On the other hand, if you’re saving towards something that’s a few years out then it could be an ideal opportunity to make your money work harder for you. 

Other things to consider before you open a Stocks and Shares ISA are also your appetite for risk and how hands-on you want to be with managing your portfolio. 

Many providers and digital advisors will assess how open you are to risk in the very earliest stages of onboarding and can help you decide what kind of stocks and shares you want to invest in; if you’re less open to negative returns then you can choose investments that are typically more stable (like funds or bonds) compared to the more volatile (like shares). At ikigai, we do this through a simple set of questions that help us understand how much risk you want to take and how best to grow your money to meet your goals. You can find out more about approaching risk in our handy article here.

Likewise, if you’re looking for a more hands-off approach, you can look for ready-made portfolio offerings, like those provided by ikigai. Whilst you should still check on any portfolio regularly to be sure it’s still meeting your needs; you don’t have to think about each stock or share yourself. It’s passive investing, which you can read more about here

What makes ikigai ISAs unique? 

ikigai is all about helping people spend well, save well, and invest well. And our new ISA offering sits within the wealth section of the app, hoping to offer a new way for us to do just that. The idea is that you can open your ISA in the same way that you can start an investing goal, helping you set, manage and achieve your financial and lifestyle ambitions. 

But ultimately, what makes ikigai’s ISAs unique is very very simple. “It’s the same thing that makes ikigai unique,” says Edgar. “It’s a way to have an ISA within a holistic banking app. The fact that my ISA is in the same app as my banking means I can look at my spare change and just say I’ll add it into my ISA. I can easily see what I’ve got spare and make investing part of my weekly or monthly habit. This is something we hope can really help people grow their money and achieve their goals.” 

In other words, like with choosing a Stocks and Shares ISA, it’s all about you and your lifestyle and your goals. It’s so important to have an account that not only suits you now, but can help you achieve the future you want. So if you’re interested in finding out more about ikigai’s ISAs, why not check them out.

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We built ikigai specifically for those who want to bring their lifestyle to the next level, by taking better care of their finances.

ikigai beautifully combines wealth management and everyday banking in one single app. And by doing so, it creates a whole new world of opportunities.

Visit https://ikigai.money to find out more.

Maurizio & Edgar, Co-Founders, ikigai

When investing your capital is at risk. Tax treatment depends on individual circumstances and may be subject to change in the future.

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Tags: , , , Last modified: 6 August 2021