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.
To get you started, 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 2014/2015) is £15,000. Next tax year (2015/2016) which starts on April 6, this allowance will rise to £15,240.
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.
The Chancellor caught everyone by surprise when, in his March 2014 Budget, he announced an increase to £15,000 taking effect from July of that year. He had already confirmed an increase to £11,880 in the 2013 Autumn Statement and the limit announced at this point generally stands until the end of the next tax year.
The 2015/16 allowance will rise in line with inflation as usual.
Can I save all of my ISA allowance in cash?
Before to 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 £15,000 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 £15,000 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.
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 £5,000 in cash.
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, 2015 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.
Once you have invested the full amount, it’s also sensible to leave it untouched for as long as possible as any money withdrawn will still count towards your allowance – even if the tax year is not yet at an end. That means if you invest the maximum £15,000 and then take out £1,000, you cannot top up your account to £15,000 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.