If you’ve got an individual savings account (ISA), it’s important to know what your ISA allowance is. Here’s a breakdown of how it all works.
What is an ISA allowance?
An individual savings account (ISA) allows you to save and invest money in a tax-efficient manner. If you open an ISA, you will not pay Income Tax or Dividend Tax on any interest or dividends that you earn from it. Profits from ISA investments are also exempt from Capital Gains Tax.
However, there is a limit to how much money you can put into an ISA each tax year. This is known as the ISA allowance.
What’s the ISA allowance for the 2022/2023 tax year?
This ISA allowance for the 2022/2023 tax year is £20,000. This is essentially the maximum amount you can put into an ISA between 6 April 2022 and 5 April 2023 to enjoy tax-free interest, income and growth.
Why is there a set allowance?
Taxes on savings and investments are an important source of government revenue. However, the government understands that if people had to pay tax on every single pound they saved or invested, many would be discouraged from saving or investing.
Setting a fixed amount of money that people can save or invest tax free is basically the government’s way of encouraging people to save or invest for their future while also ensuring that it does not completely cut off a vital source of revenue.
How is the allowance calculated?
Before 2017, the ISA allowance increased yearly in line with inflation (as measured in September of the previous year). However, since 2017, the allowance has been frozen at £20,000.
At the moment, there is no indication of when the freeze will be lifted and when the ISA allowance could begin to rise again.
How much money can you have in an ISA?
While the maximum amount of new money you can put into an ISA each year to enjoy tax-free returns is £20,000, there is no limit to the total amount of money you can have in your ISA in total.
Can you pay into two ISAs?
In a word, yes. You can distribute your ISA allowance among four different types of ISAs (cash ISAs, stocks and shares ISAs, innovative finance ISAs, and lifetime ISAs).
However, you can only put money into one of each type of ISA in the same tax year. So, if you have two cash ISAs, you can only put money into one of them in one tax year.
What if you exceed your ISA allowance?
Typically, your ISA provider will have systems in place to ensure that you do not exceed your allowance. For example, any amount in excess of £20,000 will be rejected or returned to the originating account or sender.
However, if you have ISAs with multiple providers, it’s possible to go over your allowance unknowingly.
HMRC checks individual ISA records at the end of each tax year and will know if you have exceeded your ISA allowance. They may request that the provider(s) return the excess amount and tax any interest, income, or profits resulting from it.
If you realise that you have exceeded your limit, the best thing to do is to contact HMRC via their ISA helpline on 0300 200 3312. They can advise you on your next steps. What you should not do, according to HMRC, is try to fix the problem yourself by taking action such as withdrawing the oversubscribed amount.
Can you carry your ISA allowance into the next tax year?
Your ISA allowance is reset at the beginning of each tax year. The allowance, or any portion of it that isn’t used, can’t be carried over into the next tax year.
That’s why it’s always a good idea to make the most of your allowance each year to avoid losing it.
What happens to your ISA allowance if you want to withdraw cash?
When you withdraw cash from your ISA, what happens to your limit depends on whether it is a flexible ISA or not.
If you have a flexible ISA, you can take money out and put it back in during the same tax year without it affecting your annual allowance.
If you withdraw money from a non-flexible ISA, you can’t put it back in the same tax year.
So, before withdrawing funds from an ISA, check with your provider to see whether it is a flexible ISA.
Currently, flexibility is offered through cash ISAs, innovative finance ISAs and cash held in a stocks and shares ISA. It’s not available for lifetime ISAs and any element of a stocks and shares ISA that is not cash.
What’s the best type of ISA account?
The best ISA account for you will depend on your circumstances. For example, you’ll need to consider how long you are willing to save or invest your money without touching it.
As a rule of thumb, if your time frame is less than five years, a cash ISA is likely to be a good option for you.
If you are saving to buy your first home, you may want to open a lifetime ISA. Although it has a lower limit of £4,000 per year, a lifetime ISA comes with the added benefit of a free government bonus of 25% of however much you put into it, which can help you save for a house deposit faster.
But if you have a longer time frame (over five years) and can withstand a degree of risk, you should consider a stocks and shares ISA. Over a long period of time, investments such as shares and funds can offer much higher returns than cash. See our top-rated stocks and shares ISAs to get started.
In a nutshell, think carefully about what you need from an ISA. Then do some research to determine the ideal account for you.
The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.