I could use someone to explain in layman's terms...

ifup

Hello all,

I’ve been sitting on a lump sum of cash and I’m not doing anything with it (26k in total, although in two different bank accounts). A friend of mine told me that I should’ve put that in savings or invest with it. Truth be told, I have thought about this but when it came to seeing what my options were I’m generally overwhelmed by the amount of information out there and I’m paralysed by the choices available. The advice I keep hearing is that I should invest whilst young. Well, how young? 18? Whilst I was in uni? I’m nearing 28 soon! I have spent the entire afternoon with 20+ browser tabs opened just trying to familiarise myself with these sorts of things.

I’ve read a few guides about ISAs and I just finished reading this guide: (okay can't post link but it's titled Personal Saving Allowance)  I think I have a general idea of what things are but I could really use someone to explain a couple things in layman’s terms. My understanding of an ISA is that it’s just a regular bank account where I put money in. The bank does stuff with that amount but after a year or so, I get it back with some extra (basically the interest). That’s as far as I’ve understood it. What I would like to know is:

1. A silly question but what’s the point of them and who are they for? Is it only just to help people save money? I have my salary paid into my bank account. I thought I was saving money by not spending it, but I think I’m being a bit naive with that thought.

2. If I put money in an ISA account, what happens at the end of a tax year? I’m guessing I get some sort of message saying the money is in the account with the interest, so would there be some kind of button (assuming online) to say to reinvest for the next year? Is this when compound interest apply?

3. Is there a limit to how much I can open an ISA account with? I’ve seen £20,000 as a figure but I’ve read that as the amount of interest I can accrue without it being taxed. So hypothetically speaking, let’s say I had some amount in an ISA and at the end of the tax year I’ve gained £1000 in interest. This doesn’t get taxed, but let’s say I had some amount that got me over the £20k interest allowance; does the tax apply to the total interest earned or does it apply to the amount minus the 20k? Does that extra cash sit in the account? Will I get taxed the moment I pull any of that cash out?

4. I know there are loads of ISA; Cash, Lifetime, Help to Buy and, Stocks (there may be more that I’ve missed). Each of them have their own things that makes them different from each other. The stocks one is a bit puzzling to me. Whenever I think stocks, I think of some web platform where you can then choose to buy shares in a company. I initially thought that before you can do that, you have to open an Stock specific ISA but that seems different. Am I right in thinking that a stock ISA is basically paying into some kind of pot, which then gets added to a mutual fund whereby a manager then uses it, a bit like a private pension fund?

5. How exactly will I have to pay back tax when needed? Is it done through the PAYE system?

6. So I read that the interest rates from ISA are not really worthwhile now since the returns aren’t that great. Is it still worth opening one though?

As you can guess by the kinds of questions I’m asking, I’m not too savvy when it comes to personal finance. If means anything, I do have a spreadsheet that I use to keep track of my expenses. I don’t have any outstanding debts or loans (other than student loans) and I’m always on time with paying bills. I know the questions are long winded, but I appreciate all the help.

macman

Is your nest egg in a current a/c at present, earning nothing, or in a savings a/c? If the latter, at what rate?
An ISA is like a wrapper, that you can put around various types of savings accounts. But they are tax free. You can put up to 20K each tax year into one, and, as long as it stays there (or is transferred directly to another ISA provider), you pay no tax on the interest. So that is an immediate 20% boost in interest. A Cash ISA is just like a savings account: it pays a fixed rate of interest per year. and your investment is secure, up to £85K. A Stocks & Shares ISA is basically the same as buying into funds on the stock market, but again, it is tax-free. S&S ISA's offer much higher potential rewards, but are dependent on the market, so you can potentially lose some or all of your investment: there is no guaranteed rate of return. Not suitable for the novice investor.
Since you can earn £1,000 pa in interest tax-free anyway, an ISA paying the same rate as an ordinary savings account is only a better bet if you are going to exceed that £1K of interest-which, on savings of £26K, you are not. So you are probably better off going for a conventional savings account with bettr rates than a Cash ISA: the MSE savings guide on the main board tells you all you need to know. Rates depend on what access you need, or how long you are prepared to invest for.
Since you are under 40, then, as long as you are not already or formerly a property owner, a Lifetime ISA (LISA) should be your first investment. Save up to £4K pa in that and you'll get a 25% tax boost every year until you hit 40: so £12K free, on top of the interest paid. Nothing else comes close to paying 25%. You can contribute to both a LISA and a conventional ISA in the same tax year.

tacpot12

I can answer question 1 for you tonight. The others will have to wait until tomorrow. 

ISAs are for people who want to avoid paying tax on interest, dividends or capital gains that would normally be taxable or or who just want to avoid the complexities of paying/not paying tax on their savings or investments.

Not all interest and dividends are taxable - you have already found out that you have a personal savings allowance.  You also have a dividend allowance and a capital gains tax allowance. These mean that you won’t pay tax on modest levels of interest, dividends and capital gains. 

By putting your money in an ISA you can make more than these modest gains without paying tax, but you might also choose to put money into anISA because the process of using these allowance is not always straightforward. 

masonic

ifup said:

1. A silly question but what’s the point of them and who are they for? Is it only just to help people save money? I have my salary paid into my bank account. I thought I was saving money by not spending it, but I think I’m being a bit naive with that thought.

See answers above

ifup said:

2. If I put money in an ISA account, what happens at the end of a tax year? I’m guessing I get some sort of message saying the money is in the account with the interest, so would there be some kind of button (assuming online) to say to reinvest for the next year? Is this when compound interest apply?

Nothing happens at the end of the tax year. The account remains an ISA and you continue to get the benefits in subsequent tax years. Rather like a normal savings account.

ifup said:

3. Is there a limit to how much I can open an ISA account with? I’ve seen £20,000 as a figure but I’ve read that as the amount of interest I can accrue without it being taxed. So hypothetically speaking, let’s say I had some amount in an ISA and at the end of the tax year I’ve gained £1000 in interest. This doesn’t get taxed, but let’s say I had some amount that got me over the £20k interest allowance; does the tax apply to the total interest earned or does it apply to the amount minus the 20k? Does that extra cash sit in the account? Will I get taxed the moment I pull any of that cash out?

You have an annual allowance of £20,000, of which up to £4,000 can be paid in to a Lifetime ISA, if you are eligible. There is no limit to the total balance or total amount of interest that would be tax free. There is no tax to pay upon withdrawals, but if you withdraw from a Lifetime ISA then you may be subjected to a 25% penalty if you don't meet certain conditions (over 60, using money for a house purchase as a first time buyer).

ifup said:

4. I know there are loads of ISA; Cash, Lifetime, Help to Buy and, Stocks (there may be more that I’ve missed). Each of them have their own things that makes them different from each other. The stocks one is a bit puzzling to me. Whenever I think stocks, I think of some web platform where you can then choose to buy shares in a company. I initially thought that before you can do that, you have to open an Stock specific ISA but that seems different. Am I right in thinking that a stock ISA is basically paying into some kind of pot, which then gets added to a mutual fund whereby a manager then uses it, a bit like a private pension fund?

Yes the S&S ISA account is just like a general investment account. You pay money in, and once that money is inside the account you can use it to invest in investments of your choice, which you can buy and sell within the account free of capital gains tax and income tax on dividends and interest.

ifup said:

5. How exactly will I have to pay back tax when needed? Is it done through the PAYE system?

There won't be tax to pay on your ISA savings/investments. If you have tax to pay on your non-ISA income (for example if you are a basic rate taxpayer and earn more than £1,000 in interest in a tax year) then you may need to declare this to HMRC and it would normally be collected through adjustment to your tax code.

ifup said:

6. So I read that the interest rates from ISA are not really worthwhile now since the returns aren’t that great. Is it still worth opening one though?

Cash ISAs are not really worth it for the majority of people, who can already get all of their interest paid tax free, and those paying some tax at 20% may still find rates on normal savings accounts are higher than cash ISA rates and they wouldn't make a saving overall when using an ISA. But S&S ISAs continue to be useful as they release you from the need to keep detailed records of your investments for tax purposes.

ifup

macman said:

Is your nest egg in a current a/c at present, earning nothing, or in a savings a/c?

It's an account not earning anything at the moment.

macman said:

Is your nest egg in a current a/c at present, earning nothing, or in a savings a/c? If the latter, at what rate?
An ISA is like a wrapper, that you can put around various types of savings accounts. But they are tax free. You can put up to 20K each tax year into one, and, as long as it stays there (or is transferred directly to another ISA provider), you pay no tax on the interest.

masonic said:

There won't be tax to pay on your ISA savings/investments. If you have tax to pay on your non-ISA income (for example if you are a basic rate taxpayer and earn more than £1,000 in interest in a tax year) then you may need to declare this to HMRC and it would normally be collected through adjustment to your tax code.

So if I understood it correctly, I could put money in a ISA and that pot would grow over time. Should a day come where I decide to pull some money from it, as long as it isn't in the middle of the tax year, I could do so without paying additional tax?

masonic

ifup said:

macman said:

Is your nest egg in a current a/c at present, earning nothing, or in a savings a/c? If the latter, at what rate?
An ISA is like a wrapper, that you can put around various types of savings accounts. But they are tax free. You can put up to 20K each tax year into one, and, as long as it stays there (or is transferred directly to another ISA provider), you pay no tax on the interest.

masonic said:

There won't be tax to pay on your ISA savings/investments. If you have tax to pay on your non-ISA income (for example if you are a basic rate taxpayer and earn more than £1,000 in interest in a tax year) then you may need to declare this to HMRC and it would normally be collected through adjustment to your tax code.

So if I understood it correctly, I could put money in a ISA and that pot would grow over time. Should a day come where I decide to pull some money from it, as long as it isn't in the middle of the tax year, I could do so without paying additional tax?

There will be no tax to pay regardless of when you withdraw the money. Of course, once the money has left the ISA and you start to earn interest on it in a normal savings account, that interest would be taxable.