Tax Free Savings Accounts to help you Build your Future

| 7 Nov 2012 | 0 Comments

The importance of financially securing your future has become even more apparent in recent times due to the ongoing recession and widespread redundancies faced by individuals in the UK and beyond. With redundancies rising and tax rates creeping higher, it is essential that individuals take responsibility for protecting their money and building a financially secure future for themselves. One of the most effective methods of saving money and gaining asset protection is through a tax-free savings account (TFSA). UK residents can open a TFSA, also known as an Individual Savings Account (ISA) and enjoy a range of associated financial benefits.  

tax free savings accountsAn Individual Savings Account (ISA) is a type of bank account that is created for the sole purpose of benefiting from tax-free savings at favorable interest rates. Any person, irrespective of their age or financial standing, can open an ISA, transfer after-tax money to the account, and benefit from tax-free savings; this is because no tax is charged on interest accrued on the account holder’s funds. Most reputable banking institutions in the UK will offer some form of ISA for their banking customers, however the requirements and interest rates may vary depending on the banking institution.

Can an ISA benefit me?

In light of the ongoing and problematic financial environment, saving money is viewed as a sensible approach to securing one’s future. Although many people may wish to invest their funds into diverse investment portfolios of property, stocks and foreign exchange commodities, turbulent markets have rendered these options as high risk and unsafe for those who cannot afford to lose the money they invest.

Instead, banking institutions are promoting the establishment of savings accounts. Unlike traditional savings accounts where the account holder cannot access their funds until a certain period has lapsed, certain ISAs allow for the account holder to access their funds as and when they need to; an example of such an account is the Nationwide ISA.

Individuals who hold investments outside of their ISA will be liable to income and capital gains tax, however, money held within the account is exempt from this tax liability.

Benefits of opening an ISA:

✔  Tax free interest

✔  Interest gained does not count against your ISA allowance in following years

✔  Interest can be withdrawn or transferred by the bank into your ISA

✔  Monies can be held in a stocks and shares ISA, of which some can be saved in a cash ISA

✔  Pay money into your ISA by cash or cheque

✔  Regular payments can be set up from one account to your ISA

✔  Certain ISAs allow for the account holder to withdraw money at any time

✔  Annual statements are sent to account holders detailing the amount they have saved and the interest earned

✔  Effective form of asset protection and security against tax authorities

✔  No capital gains tax or income tax on your returns

✔  ISAs do not have to be recorded on your tax return

Understanding ISAs

UK residents can invest a maximum of £11,280 in a Stocks and Shares ISA, of which £5,640 can be saved in a Cash ISA. The type of investments that can be held in your ISA will vary depending on the banking institution you open the account with, but usually the following investments can be made:

  • Trusts
  • Shares
  • Bonds

Those who open an ISA should accept that the account is not an investment tool, but instead it is considered a ‘wrapper’ for your wealth to ultimately enable it to grow on a tax-free basis.

A basic understanding of how a regular savings account works is required in order to appreciate the advantages offered by an ISA. Essentially, a standard savings account will charge higher-rate taxpayers 40% on their interest earned, while basic-rate payers are charged 20%. This is a significant amount of money lost due to tax and so the importance of a tax-free savings account becomes more apparent.

Knowing which ISA suits you

ISAIt is vital that you do your research before opening an ISA account. This is because each financial institution will provide their own set of rules and requirements to satisfy. The variety of ISAs are broad with respect to interest rates and accessibility. Accounts can range from a respectable 3.06% interest rate accounts, which give access to your funds whenever you need it, to favorable 4.05% interest rates on a five year fixed accounts.

Where banks state that their ISAs are ‘5 year fixed rate accounts’, this means that account holders cannot access their funds for the first 5 years of having the ISA. Similarly, with a 1 year fixed rate account, holders cannot access their money for 12 months upon opening the account.  Oftentimes, banks will require a minimum initial deposit to open an ISA, ranging from a mere £1 deposit to a minimum of £1,000. Individuals should therefore be aware of all requirements relating to their chosen ISA.

Types of ISAs

Stocks and Shares ISA allowance:

Those who are interested in investing in shares quoted on stock exchange markets worldwide, and who seek a greater return on their ISA funds, should consider opening a Stocks and Shares ISA. This type of tax-free savings account offers greater possibilities for a high return on invested funds compared to the Cash ISA, however, the risks are slightly greater too.

Cash ISA allowance:

A popular alternative to the Stocks and Shares ISA, the Cash ISA has an annual allowance of £5,640. Again, the interest made on this sum is tax-free, however it should be noted that once you have reached the maximum level of allowance, any money withdrawn from the account cannot be replaced. Additionally, if you do not transfer the full £5,640 inside of the tax year, your allowance will not carry over to the next year.

Individuals should research thoroughly into the available Cash ISAs to ensure their account meets their financial goals. For example, there are 3 primary types of Cash ISAs; easy access, notice accounts and fixed rate. Be sure to ask your bank manager which accounts they offer and which ISA will enable you to reach your personal and financial objectives.

Junior ISA limit:

Parents who wish to provide for their children are advised to open a Junior ISA. This remains one of the most effective vehicles in saving money for a child’s education or other future aspirations such as buying property or investing.

junior ISAThere are several benefits to setting up an ISA for your child, one of which is the fact that money and interest accrued in the Junior ISA is not available to the child until they reach the age of 18. This ensures that money will be saved, rather than withdrawn.

The amount of money that can be invested in a Junior ISA is £3,600 and this is applicable for each tax year. If the £3,600 allowance is not reached, the allowance will not carry over to the following year. The money inputted into the account can be invested in stocks and shares, cash or a combination of both. Junior account holders must be 16 or over in order to invest in stocks and shares however.

Rules surrounding the set up of a Junior ISA:

  • Only parents or guardians can set up a Junior ISA
  • The Junior ISA must be established in the name of the child
  • Account holders must be UK residents

It should be noted that children who are 16 or over have the right to open their own Junior ISA provided they are a UK resident and do not have a Child Trust Fund.

Saving for tomorrow…

Overall, ISAs remain one of the most steadfast ways of building up your wealth whilst shielding it from being taxed. Whether you wish to save for a particular purchase or investment, or you want to fund your retirement, opening an ISA can provide you with the means of achieving your financial goals.

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Category: Individual Taxation

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