Use it or lose it: how you could use your remaining 2020/21 ISA allowance

2020 has been a confusing year for most investors, with many savers/investors unsure where the best place is for their money as the Coronavirus pandemic swept the world and caused financial chaos. 

Although the ISA market was affected by COVID-19 - with severe stock market fluctions and rock-bottom low interest rates on the Cash ISA - the accounts are still an important consideration for investors hoping to maximise returns. 

This is true now more than ever, as the ISA tax wrapper - which shields returns from all income tax and capital gains tax (CGT) - could help some investors avoid a hefty capital gains tax bill, as a review by the Office of Tax Simplification urged the Government to cut the CGT annual allowance and align rates more closely with income tax.

So, now could be a good time to start thinking about how you're going to use the remainder of your annual ISA allowance.

There are four main types of ISA, each boasting their own benefits. These are:

• Cash ISA 
• Stocks and Shares ISA
• Innovative Finance ISA (IFISA)
• Lifetime ISA 

The sheer variety means there’s an ISA for every saver and/or investor, whether your goals are to save for your first home, or build a healthy retirement pot.

The ISA allowance in 2020/21 is £20,000, and though it’s stood at this amount since the 2017/18 tax year - when it rose from £15,280 - it is subject to change.

But, one thing generally remains the same - for a Cash ISA, Stocks and Shares ISA and an IFISA, the ISA allowance is the maximum that investors are able to subscribe. It’s a little bit different for Lifetime ISAs though - in the 2020/21 tax year, the limit for Lifetime ISAs is £4,000. 

Cash ISA

The Cash ISA is the most popular - and easiest to wrap your head around - ISA on the market. Cash ISAs are a savings product offered by regulated banks and building societies, and the big difference between a Cash ISA and a regular savings account is the tax wrapper, making all interest earned on savings in a Cash ISA tax free - as long as the deposits are within the annual tax free allowance (more on that further down). 

There are three variations of Cash ISA - instant-access, fixed-rate and flexible. 

An instant-access Cash ISA does what it says on the tin - you have access to your money instantly, whenever you need it, and aren’t charged a penalty when you choose to withdraw. Some providers may impose limits on this however, so it’s important that you check the rules with your chosen provider. 

A fixed-rate Cash ISA often offers higher rates than the likes of an instant-access Cash ISA, but with a fixed-rate Cash ISA, you’re committing to locking away your money for a set period of time. This commitment is then rewarded with a fixed interest rate, so the longer the term, the more interest you’ll earn. A fixed-rate Cash ISA isn’t for you if you think you’ll need easy access to your money though, so make sure you’re not locking away more than you can afford to. 

Flexible Cash ISAs allow savers to deposit, withdraw and replace money in their account without it affecting their tax free ISA allowance - as long as it is all done within the same tax year. 

For example, if you placed your whole 2020/21 ISA allowance of £20,000 into a Cash ISA at the beginning of the tax year, and later in the year needed to withdraw £5,000 of it, you could replace that £5,000 in the same tax year even though it would mean you have technically deposited £25,000 into your ISA - which is over the tax-free allowance. 

Anyone who is over the age of 16 and lives in the UK can open a Cash ISA, but they’re primarily aimed at those wanting to save in a low-risk way with easy access to their funds.

Though they are one of the safest ISAs on offer, it’s important to note that they also offer the lowest rates of interest. The best easy-access Cash ISA on the market is currently sitting at 0.6%. 

Stocks and Shares ISA

A Stocks and Shares ISA is an investment product that lets investors put their money into a range of different investments including bonds, funds and shares. Stocks and Shares ISAs are used to invest into individual companies, and they’re generally managed by an online platform or broker. 

There are usually fees associated with opening, holding, changing and withdrawing investments in a Stocks and Shares ISA - this should be looked at on a provider to provider basis - but all interest and profits made from share price increases are tax free. 

Because of the volatility of the stocks and shares market, it’s recommended that you keep your investments in a Stocks and Shares ISA for at least five years - this gives you time for any falls in the value of your assets to recover. This means that, not only must you be happy with the higher risks that accompany a Stocks and Shares ISA, but you should be comfortable with locking your money away and not having instant-access. To match the higher risk, Stocks and Shares ISAs offer higher average returns than Cash ISAs, at around 4%+ over the long term. 

To be eligible to open a Stocks and Shares ISA, you must be 18 or older and a UK resident. Stocks and Shares ISAs are generally better for investors with a longer term outlook, and it’s important to remember that returns are not guaranteed - you may not get back the amount invested. 

Innovative Finance ISA (IFISA)

Then there’s the IFISA, which is uncorrelated to both the fluctuations of the stock market, and the Bank of England (BoE) base rate, which is currently at a record low of 0.1%.

An Innovative Finance ISA (IFISA) is an investment product that allows investors to invest in debt-based securities and loan funds through the peer-to-peer lending market without paying tax on interest or capital gains. 

Potential returns from an IFISA range between 4% and 8%, and through the account, you can invest into:

• property
• green energy projects
• consumer loans
• SME loans

The underlying asset that you choose to invest into will depend on your personal goals, circumstances and interests.

It's worth considering that throughout the Coronavirus pandemic, property is a sector that has proven itself to be relatively resilient. 

And when investing into the likes of a CARLTON Bonds IFISA, investors are supporting regional house builders in delivering much-needed, high-quality housing, creating jobs and, in turn, aiding in the bounce-back of the UK's economy.

Lifetime ISA (LISA)

The Lifetime ISA (aka LISA) is a government-backed savings or investment product that allows savers and/or investors to save for their retirement pot or to purchase their first home. 

The LISA offers a generous 25% government bonus - the same as the Help to Buy ISA which closed to new savers on November 30th 2019 - that can either be used by first time buyers to help with the costs of buying their first home, or it can be kept locked away until the age of 60 for use as a retirement fund. Cash LISAs offer similar average returns to Cash ISAs, currently standing below 2%.

To be eligible to open a LISA, you must be between the ages of 18 and 39, and you can continue to save into the account until you turn 50. If you want to benefit from the 25% government bonus, you can only withdraw funds from your LISA before the age of 60 if it’s going towards the purchase of your first home. After 60, you can withdraw your funds - with the government bonus - at any point, penalty free. 

Choosing the best type of ISA

Now that you have a general overview of ISAs, it’s important that you take into account the risks as well as the returns of any investment or savings product  before making any decisions. 

The amount of risk you should take with your investments is completely unique to you and your risk profile. You should always speak to an independent financial advisor, who can make appropriate investment recommendations based on your personality, goals and circumstances, and having a general understanding of the risks and returns of each ISA is crucial. 

Cash ISAs are considered the safest - as a savings product, your capital is not at risk, and you’ll always get back the same amount of money that you deposited.

Stocks and Shares ISAs are best suited to investors looking for longer term investment, because due to the volatility of the stock market - where the performance of investments can fluctuate - investors should allow time for any losses to recover. 

The risks of IFISAs differ depending on the type, and whether they’re asset-backed. IFISAs are an investment product, and whilst they can offer higher returns compared to that of a Cash ISA and lower risk compared to that of a Stocks and shares ISA,  capital is at risk and returns are not guaranteed. However, even if your investment is secured against assets, an economic downturn could still affect returns and you may not get back the amount you invested. 

Read more: How many ISAs can you have?

So, now you know your options when it comes to allocating the remainder of your 2020/21 ISA allowance. It’s time to think carefully about which one sounds the most beneficial for you, weighing up your goals, circumstances and the risks and returns. You should also speak to an independent financial advisor, who can help you choose an appropriate investment strategy. 

Remember: you can’t carry your ISA allowance over into the new tax year, so you either use it, or you lose it.

Originally published January 20 2020, updated November 26 2020.