Five ISA myths exposed

What you’ll learn:

• Why changes to the dividend allowance might make ISAs more important.
• How ISAs are more flexible.
• How you can hold cash in your Investment ISA until you decide where to invest.

This tax year (2024-25), you can put up to £20,000 into ISAs and any returns you make on money within an ISA is tax-free, making them an attractive option for some savers and investors. It is only a matter of weeks until the end of the tax year – on 5 April. The rules governing the annual ISA allowance are simple – if you don’t use it, you lose it.

In case you’re not sure whether an ISA could benefit you, we’ve debunked some of the main ISA myths which often cause confusion.

Bear in mind ISA rules may change in future, and that the value of any favourable tax treatment to you will depend on your individual circumstances. And remember, the value of investments can fall as well as rise.

Myth one – You can only have one ISA each tax year

There are different types of ISAs: cash, investment (also called stocks & shares ISAs), Lifetime and Innovative Finance (which enable you to invest in peer-to-peer lending).

You can split your annual allowance between more than one type of ISA, so you could put some in a cash ISA and some in an investment ISA, for example. You can also pay money into more than one of the same type of ISA in the same tax year.

Once the new tax year starts on 6 April, you would be allowed to open another investment ISA with a different provider, should you wish.

There are a number of reasons why transferring your Individual Savings Account (ISA) could stand you and your investments in good stead, although make sure you’re aware of the potential drawbacks too.¹

Myth two – The Dividend and Personal Savings Allowances mean ISAs aren’t worth bothering with

One of the main attractions of ISAs is that any money you make is tax-free. However, there are other tax allowances which mean you won’t necessarily pay tax on savings and investments that are held outside of an ISA, leading some to believe ISAs aren’t worth bothering with.

For example, you can receive up to £500 a year in dividend income without paying tax. This might be adequate for many people, but if you build up an investment portfolio over many years, you may find that the amount you receive in dividends exceeds the annual allowance. If that happens, basic-rate taxpayers must pay 8.75% on any dividends above the £500 allowance. Higher-rate taxpayers pay 33.75% and additional-rate taxpayers pay 39.35%. ISAs help protect against this risk.

Similarly, gains on investments are liable to capital gains tax (CGT). The standard CGT rate is 18%, while the higher rate is 28%. You have a CGT allowance every tax year – it’s currently £3,000 which means if you sell any investments, you’ll only pay tax on profits above that amount.

If your gains are less than that, or you plan carefully and stagger the sale of your investments over a number of years, you can avoid CGT. But if you invest within an ISA, you don’t have to worry about the amount of profit you may have made when you want to sell as CGT won’t be applicable.

Another allowance, the Personal Savings Allowance (PSA), enables you to earn interest on your savings income without paying tax. Basic rate taxpayers can earn up to £1,000 in interest each year tax-free, and higher rate taxpayers up to £500. Additional rate taxpayers don’t have a PSA. You’ll pay income tax on any interest above these amounts, unless your savings are in a cash ISA in which case all interest will be tax-free. This savings income covers several different kinds of investment income.

Myth three – You can’t take money out and pay it back in

If you hold money in an ISA, you can take it out and pay it back in within the same tax year without it affecting your annual allowance.

For example, if you’ve used £10,000 of your ISA allowance this tax year, and take out £2,000, you could put it back in before the tax year ends on 5 April, and still be able to pay in a further £10,000 – the remainder of your £20,000 allowance. Not all ISA providers offer this flexibility though, so check with yours before withdrawing any money.

Myth four – You must decide which funds or investments you want to hold in an Investment ISA before you can open one

If you want to invest this year’s allowance in an investment ISA, but haven’t yet decided where to put your money, you could pay it into the ISA but keep it as cash until you’ve made up your mind. The ability to hold cash in your Investment ISA can also be useful if you’re uncertain of market conditions and don’t want to invest immediately.

If you do decide to leave your money in cash, it is easy to forget about it, so perhaps set a reminder to come back and decide what to invest in. If you are struggling for ideas we have some ready-made portfolios, managed by our experts, suitable for investors of differing risk levels.

If you are unsure if now is the right time to invest, this is understandable but bear in mind that it will likely never feel like an ideal time to invest. There is always some bad news around which may influence our views and this can lead to missing out on longer-term investment growth.

In this case, you may want to think about setting up smaller regular automatic investments. Then you will not have to invest all at once, the price you pay will even out if there are short-term falls in value, and you don’t need to get comfortable every time you invest.

While there can be benefits to investing regularly rather than as a lump sum, you should remember the impact fees have on your investment. If you’re only investing small amounts each month, the minimum monthly fee could make it expensive and may exceed returns.

Myth five – Once you’ve chosen an ISA, you’re stuck with it

ISAs have become more flexible in recent years – it’s possible to change ISA provider and switch from cash to investments and vice versa.

You just need to make sure that the ISA you want to move to accept transfers, and check you won’t be charged a penalty, suffer any other detriment or lose any benefits from your current ISA provider if you move.

If you’re looking to transfer money you put into your ISA in a previous tax year, you don’t have to move it all. So for example, if you have £40,000 in a cash ISA and want to start investing, you could transfer some of it to an investment ISA and leave the rest in your cash ISA.

ISA customers will have the choice to transfer part or all of their balance from one ISA provider to another, regardless of when the money was paid in.

If you’re thinking of transferring money from a cash ISA and investing it, make sure you’re comfortable with the additional risks associated with investing. The value of investments can fall, although investing offers the potential of generating higher returns over the longer term, but you may also make a loss.

Please bear in mind that this article is for general information purposes only. If you’re unsure, seek professional financial advice.