ETF investing in an ISA

When it comes to building your wealth every percentage point of growth is vital. That’s why using low-cost ETFs for investing and ISAs for sheltering your gains from tax is a great combo.
 
ISAs, along with SIPPs, are the main investible tax wrappers available to UK investors over 18. (You can also invest in a Junior ISA (JISA) for children under 18.)
 
ISAs are a great way to grow your wealth because they legally protect your investments (including ETFs) from taxes on dividends, interest and capital gains. 
 
Even a small investment can grow over many years to a point where it is exposed to tax liability. Investing in an ISA saves you the trouble of worrying about this and all the tax paperwork that comes with it.
 
The tax savings alone are a big feather in an ISA’s cap. On top of that, you can withdraw cash from a stocks and shares ISA at any time. If you need money in a hurry then you can sell down your investments and lay your hands on ready cash, penalty-free, within two to five working days (depending on your platform’s service levels). 
 
That makes an ISA the best vehicle to help you hit every short and long term investment objective due before your minimum pension age.
 
Another useful feature of ISAs is that withdrawals are not subject to income tax, unlike with a SIPP. Thus there’s no danger of income from an ISA pushing you into a higher tax bracket and you don’t have to wait until retirement age (which is forever being pushed backwards) to tap your assets.
 

How much can I invest in an ISA?

You can invest up to £20,000 into a stocks and shares ISA during the tax year April 6th 2020 to April 5th 2021. If you qualify for a Lifetime ISA (LISA) then you can invest up to £4,000 of your £20,000 annual ISA allowance into that ISA type. You can also invest £9,000 per child per tax year into a JISA. This table summarises your investment options: 
   
These ISAs do not accept investment products:

• Cash ISA: cash only.
• Help to Buy ISA: cash only.
• Innovative Finance ISA (IFSA): peer-to-peer lending products.

ISA rules that apply to all types

You can put your entire annual ISA allowance into a single ISA (except a LISA), or you can split it between multiple types. For example:

• £15,000 into a stocks and shares ISA
• £4,000 into a LISA
• £1,000 into a cash ISA.

This means you can open one of each type of ISA per year and distribute your £20,000 total annual allowance between them as you see fit. The exceptions being:

• Max £4,000 into your LISA.
• Investing in a JISA uses up the child’s allowance not yours.
• New Help to buy ISAs are no longer available.

Current tax year ISA rules

You can only open one of each type of ISA per tax year. The exception is a JISA. You can open one of those per child per tax year. 
 
If you wish to transfer a current year ISA then you must transfer its whole balance. You can choose another provider and/or ISA type. 
 
For example, you could save up to £20,000 into a cash ISA and then, when the moment is right, you could transfer it into a stocks and share ISA (from the same or a different provider). 
 
Any unused annual ISA allowance is lost and does not roll over into future years.
 

Previous tax year ISA rules

ISAs opened in previous tax years are extremely flexible. You can:

Transfer any amount from an old ISA to any other type of ISA. For example, you have £40,000 in a cash ISA, you can:

• Transfer the whole balance into a stocks and shares ISA. 
• Transfer a portion of the balance into any number of stocks and shares ISAs you have open. 
• Transfer a portion of the balance into any number of other ISA types you have open.
• Transferring previous years’ ISAs leaves your current year’s allowance untouched. For example, moving £40,000 from an old ISA into your current year’s ISA still leaves you with a £20,000 ISA allowance for the current tax year.
• If you transfer £4,000 into this year’s LISA then you gain the government bonus and your £20,000 current year ISA allowance remains intact and can be fully used to fill other ISA types.

When moving your ISA, make sure you transfer it using the new provider’s ISA transfer process to maintain its tax-free status. Don’t withdraw cash or re-register assets using any other method.
 

What is a flexible ISA?

A flexible ISA enables you to withdraw and replace money from your tax-shelter without reducing your ISA allowance, provided it is done within the same tax year. Flexible ISA status can apply to stocks and shares ISAs, cash ISAs, and IFISAs, but not other types. Flexible ISAs work like this:
 

Flexible ISAs: current tax year

You can withdraw cash as much as you like in the year and can still replace it before the end. Imagine you invested £20,000 on April 6th. You can take out £19,999 throughout the year and restore it all again by April 5th, thus maintaining its tax-free status in the future.
 

Flexible ISAs: previous tax years

You can withdraw up to your balance and then replace it in the same account, maintaining your asset’s tax-free status, and leaving your current year’s allowance unaffected, as long as you return the money in the same tax year. 
 

Flexible ISAs: mixing the current tax year and previous years

This is a little more complicated and is best explained using an example:

Imagine you have a stocks and shares ISA that holds £50,000 worth of ETFs from previous years. You start the new tax year with a full £20,000 annual allowance.

• You invest £10,000 into your ISA and now have £10,000 allowance left.
• You need to sell down £25,000 of assets to meet an emergency obligation and withdraw the cash.
• The flexible ISA rules now allow you to add the £25,000 withdrawal to your £10,000 remaining allowance. You can now put up to £35,000 in your ISA until the end of the tax year.

If your ISA is non-flexible then you could only put £10,000 into it that tax year i.e. your remaining annual allowance.
 
It’s up to product providers to offer flexible ISAs and currently only a few platforms have made their stocks and shares ISAs flexible. As a customer there’s no downside to flexible ISAs (unless the provider decides to charge for them), so check with your platform if you’d like to take advantage. 

Be aware that only the cash component of an ISA is flexible. In a stocks and shares ISA that means you can flexibly withdraw and replace income payments or investments sold to cash. 

If you transfer a flexible ISA to another platform, they may not recognise withdrawals you made earlier in the tax year, so check with them to ensure that doesn’t cause you to miss out.
 

What is a Lifetime ISA?

Lifetime ISAs are offered as lifetime stocks and shares ISAs or lifetime cash ISAs. They’re best used for buying your first home or partially funding your retirement. The rules are quite intricate:

• You can invest up to £4,000 per tax year in a lifetime ISA.
• The government upgrades your contribution by 25%, capped at £1,000 per tax year. 
• Your contribution counts towards your total annual ISA allowance, but the government contribution does not – it’s a bonus.
• LISAs are available to UK residents and crown servants between the ages of 18 and 40. 
• Providing you open a LISA by the time you’re 40 then you can keep opening them until you’re age 50.
• That’s £32,000 in government bonuses that’s up for grabs. 
• You can transfer cash in from previous year’s ISAs to trigger your government bonus.
• You can withdraw your assets from age 60 or to help you buy your first house.
• If you withdraw at any other time then you’ll pay a penalty that more than wipes out your bonuses.
• First-time buyers can’t use their LISAs on a house worth more than £450,000, must use a traditional repayment mortgage, and must live in the house themselves.

How to invest in an ISA

If you’d like to invest in an ISA then simply select from one of the eligible accounts provided by your chosen platform:

• Stocks and shares ISA
• Lifetime ISA
• Junior ISA

Not every platform offers every account type. Only a few platforms currently offer flexible stocks and shares ISAs. 
 
In most cases, you will not be charged extra platform fees or dealing costs for an ISA account in comparison to a standard investment account. However, you may occasionally incur special administrative charges for certain ISA events, so check your platform’s fee schedule for any extras.
 
Most platforms will also track your annual ISA allowance so you can make sure you don’t put too much in.
 
When looking for compatible investments, a good rule of thumb is to look out for ETFs with the acronym UCITS in the name. All UCITS ETFs are eligible for ISA investment.
 
The term simply refers to a common set of European Union standards for ETF products that enable them to be used across EU markets, much as you might expect for cars or toys.
 
Will owning UCITS ETFs become a problem once the transition period ends between the EU and the UK? While nobody can say for certain, the UK’s industry regulator, the Financial Conduct Authority (FCA), and the industry’s major ETF providers have made extensive preparations to ensure that business continues as normal even in the event of a no-deal scenario. 
 
If your investment contributions outstrip your annual ISA allowance then it’s a good idea to shelter bond ETFs in your ISAs before equities. This is because bond distributions count as interest which attracts your standard income tax rate rather than the lesser dividend rate. 
 
Note, that commodity ETCs do not make distributions but will be susceptible to capital gains.
 
If you have space left over in your ISA, plus assets that are unsheltered, then you can get them under cover using the Bed and ISA manoeuvre.
 
Because you can’t move unsheltered investments straight into an ISA, Bed and ISA just means selling your taxable assets and buying them again inside your ISA, taking care not to exceed your annual ISA allowance. 
 
Selling an investment can incur capital gains tax on any growth, but you can avoid that by staying within your capital gains personal allowance. You’ll also incur costs to sell and buy your investments but once they’re within your ISA they will grow tax-free in the years ahead.