How does the annual ISA allowance work?

ISA season is in full bloom and the countdown to the end of the tax year is on. That means there’s still time to make the most of your ISA allowance before 5 April.

If you’re having trouble wrapping your head around the allowance and rules, you've come to the right place. This article aims to shed some light on your ISA doubts, helping improve your understanding of these tax-efficient accounts.

What is an ISA and how does it work?

ISA stands for Individual Savings Account, and it is a powerful financial tool that was introduced in the late 90s to encourage people to do more with their money.

Now, there are five types of ISA on the market, but they all share the same common benefit: they give you the freedom to save or invest without paying UK income or capital gains tax:

• Cash ISA
  A Cash ISA works just like a normal savings account, except you don’t pay income tax on the interest you earn.
  
• Stocks & Shares ISA
  With a Stocks & Shares ISA, you can put money into an ISA and use it to buy shares, funds and other types of investments. Your capital is at risk when you invest in a Stocks & Shares ISA.
  
• Lifetime ISA
  Lifetime ISAs were created to give you a boost towards buying your first property if you’re between 18 and 39 years old.
  
• Innovative Finance ISA
  An IFISA lets you use the yearly allowance to lend funds directly to other investors via the Peer-to-Peer lending market. You then get interest for lending your money out. Your capital is at risk when you invest in an IFISA.
  
• Junior ISAs
  Just like the adult ISA, this account allows you to save and invest tax-free on behalf of a child. Capital at risk if you choose to invest.

Find a complete rundown of the different types here

What is the annual ISA allowance?

Every tax year, you have a maximum amount of money you can put in your ISA. This is called your allowance, and you have until 5 April of every year to add this money to your account.

In the 24/25 tax year, the allowance is £20,000. This allowance only counts for the money that you contribute to your ISAs each year. In other words, it doesn’t include the total amount in your ISAs from previous years or any returns you earn from your contributions.

How many ISAs can I have?

The new rules for 2024/25 remove the limit on opening more than one Cash ISA or Stocks & Shares ISA per year. However, you’ll still need to stay within your £20,000 annual limit across all your ISA investments.

What are the ISA allowance rules?

• You can’t pay more than £20,000 in total into your ISAs in one tax year. There's no minimum amount.
• You can pay into more than one ISA in a tax year, including accounts of the same type, as long as you don’t exceed your £20,000 ISA allowance. This applies to Cash ISAs, Stocks and Shares ISAs and Innovative Finance ISAs.
• Lifetime ISAs have different rules: You can only contribute £4,000 to a Lifetime ISA each year, and you must be over 18 but under 40 to open one.

Will my allowance roll over into next year?

Unfortunately, the allowance doesn’t roll over into the next year. On 6 April, when the new tax year begins, you will lose your ISA allowance from the previous year if you haven’t used it all.

Let’s break this down using an example:

If you were to deposit £10,000 into a Cash ISA and £5,000 into a Stocks & Shares ISA before midnight on the 5 April, you would not be able to carry the remaining £5,000 of your allowance into the following year.

However, any savings or investments held in an ISA will continue to earn interest or grow/lose value, and you will reap the tax benefits until you withdraw the money.

Why is there a limit?

Although the government created these accounts to incentivise saving and investing, it still needs to collect tax. That’s why any savings and investments outside your ISA allowance could be subject to capital gains tax. Without a limit, people could easily avoid paying taxes on their returns or interest.

Why should you use your ISA allowance?

As long as you decide to follow the above rules, no profits from your savings or investments will incur UK income tax or capital gains tax (CGT). You also don’t pay tax on dividends from shares held in an Stocks & Shares ISA.

💡A dividend is a portion of company earnings distributed to some or all of its investors. You earn dividends from dividend stock.

Why are Cash ISAs back in fashion?

Rising interest rates have been great news for savvy savers — but there’s a potential sting in the tail if you have a few thousand pounds tucked away in a high-interest savings account.

In 2016, a savings allowance was introduced. If you earn upwards of this amount in interest, you have to pay tax on it. This allowance lets basic-rate taxpayers receive up to £1,000 of savings income and higher-rate taxpayers receive up to £500 without any tax being due.

Until recently, we didn’t need to worry about breaching the threshold, because interest rates were so low. But now, with the Bank of England rate sitting at 5.25% (as of January 2024), there’s a chance many of us could face a bill for our returns.

Cash ISAs are therefore making a comeback, as you can put your savings in there and protect it from tax.

💡 Tax treatment depends on your individual circumstances and may change in the future. Always do your own research.

How does a Stocks & Shares ISA work?

A Stocks & Shares ISA is a tax-efficient investment account, through which you can invest in different assets, such as stocks and funds.

As mentioned before, the stand-out benefit of a Stocks & Shares ISA, compared to a GIA (General Investment Account), for instance, is that your contributions are free from UK capital gains and income tax.

However, unlike a Cash ISA, there is an element of risk involved because you’re investing your money, not saving it. This means the value of your investments can go down as well as up.

For this reason, you should consider Stocks & Shares ISAs as part of a long-term strategy, leaving your money invested for at least five years. This will, hypothetically, allow enough time to ride out any bumps in the market that might see you make a loss on your money.

Despite stocks and shares historically outperforming money in savings accounts in the long term, there’s no guarantee that they’ll do so in the future.

Learn more about the long-term investing strategy “Dollar Cost Averaging” here

Discover accessible investing with a Plum Stocks & Shares ISA

With Plum, you can open a Stocks & Shares ISA and make the most of your allowance this year. It’s quick to set up your account, and the app is easy to use to help you build confidence as you invest in the funds of your choice.

Explore our blog to learn more about investing, saving and managing your money.

Please remember that, as with all investing, your capital is at risk. You shouldn’t invest in or deal in any financial product unless you fully understand it and the inherent risks.

The information contained in this article is for general informational purposes only and is not intended to constitute investment advice or any other advice or recommendation. The information provided should be used at your own risk and it is your responsibility to evaluate the accuracy, reliability, timeliness and completeness of any information available on a linked website.