If the idea of earning tax-free returns from your savings and investments appeals, look no further than Individual Savings Accounts (ISAs).
But you can’t shelter all your savings from the taxman in an ISA. HM Revenue & Customs (HMRC) sets a limit, known as the ISA allowance, in each tax year. Tax years run from April 5 to April 6.
Your ISA allowance is in addition to the new Personal Savings Allowance (PSA), which came into effect on April 6, 2016. All basic rate taxpayers can now earn £1,000 of savings interest a year without having to pay any tax on it. You’re a basic rate taxpayer in the 2016-17 tax year if your income is less than £43,000).
If you’re a higher rate taxpayer, paying tax at the 40% rate on an income between £43,001 and £150,000, you’re entitled to a lower PSA of £500 a year.
If you’re an additional taxpayer earning £150,001 or more, you won’t get an allowance at all.
Here’s your guide to this year’s ISA allowance.
How is the ISA allowance calculated?
The ISA allowance, which generally goes up slightly every tax year, is calculated using the inflation figure as measured at September of the previous year. The inflation measure used for this purpose is the Consumer Prices Index (CPI).
"The ISA allowance is calculated using the inflation figure as measured at September of the previous year..."
What is the ISA allowance for this tax year?
The current total ISA allowance (for the tax year 2016/2017) is £15,240. It will increase to £20,000 in the 2017/2018 tax year.
Who calculates the ISA allowance?
The annual ISA allowance is set by HMRC and confirmed by the Chancellor of the Exchequer in his Autumn Statement, a sort of ‘mini Budget’ that takes place towards the end of the year.
Can I save all of my ISA allowance in cash?
Before July 1, 2014, you could only invest half your annual ISA allowance into cash. However, following changes to ISA rules, you can invest the full £15,240 allowance into a cash ISA. This is an interest-bearing account that carries no risk, although as interest rates are so low, your returns may be eroded by inflation.
If you don’t want to invest the full £15,240 allowance in cash, you can invest some or all of your allowance in a stocks and shares ISA, which shelters any gains from capital gains tax (CGT) but can go down as well as up in value. Or, you can invest your allowance in peer-to-peer loans through the new innovative finance ISA, launched on April 6, 2016.
You can split your allowance any way you want, so, for example, you could put a higher amount into a stocks and shares ISA – say £10,000 – and keep the remaining £5,240 in cash or innovative finance ISAs.
Why is there a set allowance?
The government makes a lot of money by taxing savers and investors’ returns, so there has to be a limit on how much each person can save tax-free.
On the other hand, the government also needs to persuade people to save more and permitting a set amount they can earn tax-free is designed to encourage this.
If I don’t use my full allowance can I carry it over to the next tax year?
No, it’s a case of ‘use it or lose it’. Whether you plan to invest in cash or stocks and shares, you won’t be able to carry over any unused allowance to the following tax year, which starts each year on April 6. This means that you have until midnight on April 5, 2017 to use up this year's ISA allowance, or it will be gone for good.
You should always try to make use of your ISA allowance as soon as possible once the new tax year starts to maximise tax-free returns.
Under new flexible ISA rules which can into effect in April 2016, any money you withdraw from your cash ISA, or a cash holding in an investment ISA, and then pay back in, will not count towards your allowance. That means if you invest the maximum £15,240 and then take out £1,000, you can top up your account to £15,240 again.
What if I go over my ISA allowance?
Under normal circumstances, your ISA providers will not allow you to exceed your allowance – the money will simply be rejected or paid back into the account it came from. If you do manage to exceed the allowance, you should let your provider and HMRC know, and you will not be entitled to any tax advantages on the overpayments.
The same is true if you open more than one cash or stocks and shares ISA in any one tax year. In either instance, HMRC has an ISA Helpline (0300 200 3312) that you should call.
What are the best accounts to save my allowance in?
Savings providers usually start unveiling their ISA deals as the new tax year approaches – MoneySuperMarket’s ISA channel is the perfect place to stay up to date with any changes.