Five ISA tips and traps
We look at some common ISA pitfalls and explain how you could avoid them.
Millions of savers and investors use ISAs to shelter their hard-earned cash and investments from the taxman. The appeal is simple. ISAs offer UK tax-free status and usually the ability to withdraw whenever you need to, but this doesn’t mean there aren’t any hazards.
Here are some common mistakes made by ISA savers and investors, as well as quick and easy tips to help you avoid these pitfalls. Remember though, tax rules can change. The value of any tax benefits will also depend on individual circumstances. The information in this article is provided to help you make your own decisions but is not personal advice. If unsure, please seek advice.
1. Choosing the right type of ISA
TRAP: This tax year, you can save up to £20,000 in ISAs and split the contribution between a Cash ISA, a Stocks and Shares ISA, a Lifetime ISA and an Innovative Finance ISA. While all offer a range of great tax advantages, they serve different purposes and you could pick the wrong type of ISA for your circumstances.
TIP: In general, you might want to think about Cash ISAs if you need to access your money in the next five years, or if you’re not comfortable with the risks of the stock market. But if you’re looking to invest for the longer term (over five years) and are comfortable with the risks, you could consider a Stocks and Shares ISA.
When held over the longer term, investments (such as funds and individual shares) could offer better returns than cash. But they come at a higher risk as they will fluctuate in value, meaning you could get back less than you put in. If this worries you then a Stocks and Shares ISA might not be right for you, and you might have to accept the potentially lower, but more certain, returns from cash.
As a happy medium, investors could spread their risk by putting part of their allowance in a Cash ISA and part in a Stocks and Shares ISA.
If you’re aged between 18 and 39, and saving to buy your first home or for later life you may want to consider a Lifetime ISA (LISA). You can contribute up to £4,000 each tax year (which counts towards your total ISA allowance), and the government provides a 25% bonus on top, up to £1,000 a year. Withdrawals not for an eligible first home purchase before the age of 60 may be subject to a 25% government charge, so you could get back less than you put in.
Innovative Finance ISAs allow you to lend out the money in your ISA in return for interest. As you may expect, this interest rate is typically higher than the rates offered by Cash ISAs, but the interest is not guaranteed, you could face a long wait to access your money and you won’t normally be protected by the Financial Services Compensation Scheme should things go wrong.
2. Diversification is key
TRAP: By only putting your money into one particular investment, the fortunes of your entire ISA might be at a higher level of risk than if you hold a number of different investments.
For example, investing in just a single business means all of your money is connected to the success of that company. If that one company goes bust, then you may lose most or all of your money.
TIP: Holding a mixture of investments within an ISA is important. Diversifying your portfolio improves the potential for long-term returns and reduces the impact of one investment running into trouble. This could be achieved by investing in funds where a professional fund manager will invest in a broad range of assets on your behalf. Remember that unlike the security offered by cash, all investments rise and fall in value, so you could get back less than you invest.
In the HL Stocks and Shares ISA, you can choose from over 3,000 funds as well as shares, investment trusts, corporate bonds and much more.
3. Rushing into an investment
TRAP: It’s a common misconception that you need to decide how to invest the money you add to a Stocks and Shares ISA straightaway. If you’re not sure what to invest in, you can put money in a Stocks and Shares ISA and decide where to invest later.
TIP: As long as the cash is added to the ISA before the end of the tax year, it will still count as part of the current tax year’s (2022/2023) allowance, even if the investments are made after the deadline. This means you can secure your allowance for this year and then spend as much time as you want choosing what to invest in.
If you’re worried about investing a lump sum all in one go, you could even invest a little every few weeks and gradually build up your investment portfolio over a few months.
4. Options for children
TRAP: Not putting aside any savings for your children’s future. With university costs so high along with house prices continuing to rise, any money tucked away now could make a big difference to your child’s future.
TIP: One of the most popular options for parents and grandparents are Junior ISAs. They offer shelter from UK capital gains and income tax.
The money is normally locked away until the child reaches 18, at which point the account is automatically converted to an adult ISA and they then have control over the account. This makes them particularly useful for saving towards university fees or a deposit for the child’s first home.
A Junior ISA can only be opened by the child’s parent or legal guardian but once open anyone can contribute up to £9,000 this tax year (2022/2023).
5. Missing out
TRAP: It’s easy to put off jobs, and opening an ISA isn’t top of most people’s list of fun activities, but it’s important to act sooner rather than later.
The earlier you start investing, the more time your money has to grow in value.
TIP: If you have decided to go ahead and open an ISA, before you apply, please make sure you’re happy with our terms and condistions (including tariff of charges) and key features, it then only takes about 10 minutes online.
Why not top up now and get it ticked off your to do list?