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The UK uses a very handy threshold process created for people who want to save or invest money without having to pay tax on it. 

Insurance Savings Accounts (ISAs) give residents an annual allowance of up to £20k for recent tax years — so it may be well worth taking advantage of. With Brits needing a way to put their weakening sterling to better use, this guide explains what the Stocks & Shares ISA is and how it works.

ISA

Overview: What are Stocks & Shares ISAs & How Do They Work? 💼

This section is designed to give you a very succinct overview of the whole article. Rather than having to read everything, you could just pop in here and get the gist of it. We advise that you carefully do your research before doing any kind of serious investment. We’ve compiled some of the most mission-critical data efficiently and swiftly, in order to guide your first baby steps on this topic.

What are stocks & shares ISAs? At a glance:

  • ✔️ For 2023/24, Brits can invest up to £20k into a stocks and shares ISA which can be split according to the fund type: Shares and/or Cash.
  • ✔️ You have 2 routes available to invest in this form of ISA. The first is to select your specific investments for yourself, which is referred to as a DIY investment. Alternatively, you can get a financial professional to manage the selection and reviewing of your investments, which is known as managed or fully managed.
  • ✔️ If you would prefer a professional to manage your investments on your behalf, including the optimisation of your portfolio across time, then a financial adviser can be very handy. But this will come at a premium for ongoing assistance. 
  • ✔️ Those who are looking for a budget version of that may opt for robo-advisors. These are machines using computer algorithms to attempt to optimise portfolios. A few names that do this are Nutmeg, Wealthify, and Moneyfarm. 
  • ✔️ The most hands-on approach is to use the online trading broker that lets you place your all positions. For anybody who wants to be able to access their money without having to wait a minimum of five years, then you may be best off with a Cash ISA. View HMRC’s guide

History of Stocks and Shares ISAs 🏛️

In 1999. Gordon Brown, then Chancellor of the Exchequer, announced a new scheme called the ISA—a financial relief system to save cash. 

At the time, it was met with poor journalistic reception. Indeed, one Labour MP Quentin Davies called ISAs a “colossal failure” only months after their beginning. In spite of this, ISAs have slowly taken root in Britain and did become an integral aspect of many people’s saving strategies; indeed nearly a trillion has been put into ISA holdings in the last 20 years.

Since its acceptance, the central perk to using an ISA remains the same. Users make interest or returns on their investments without being taxed. This form of tax relief/efficiency replaced other vehicles that were less effective. For instance, at one point we had something called Personal Equity Plans (PEPs)—they worked quite similarly to Stocks and Shares ISAs. While the Cash ISA has some similarities to the now-defunct Tax-Exempt Special Savings Accounts (TESSAs).

When these two incentives were put into effect, ISA allowances got divided between investment and cash capital. At the beginning of the scheme, this allowance was set at £7,000 for stocks and shares, with £3,000 allotted as cash accounts allowances. 

However, something changed in July, 2014. The way that subscription limits were divided between these two types of ISA were opened up—consumers were allowed to decide how they wanted to split the divide. And ever since 2017, the funding limit has been set to £20,000 for tax-free savings and/or investments.


Cash ISA vs. Stocks & Shares ISA 📊

Cash ISAs are really no different to a regular savings account that you might open up with the bank. The main difference is that you are not taxed up to a certain allowance. By comparison, a stocks and shares ISA will see your money invested into the traditional financial markets. There is no guarantee that your money will make you a return, whereas the cash ISA will give you a return from interest.

What is an ISA?

In essence, using an ISA means that you can invest or save cash to a cap of £20,000 that is tax-free regarding any ROI or interest that your funds accrue.

As we said earlier, this capability was introduced in 1999 when the Tony Blair-headed government put this scheme in place. How much you can put into your ISA will vary according to that year.

What is an ISA

For instance, the year finishing 2019 was capped at £20,000, which it currently still is at the time of this writing. And you can use this capital or in any combination and ratio of stocks and shares ISA, Cash ISA or just one of either. Any money that you accrue from this is tax-free up to the limit.

 

Whatever interests or gains that you derive from your stocks and shares ISA, and/or your cash ISA — are free of tax up to the yearly limit of £20,000.

 

Note that the ISA time window is the same as the regular British tax year, which opens up on 5 April and closes on the fourth of the next year. This means that, if you make no use of your allowances, this will be carried across to the following year. Also, there is a significant difference between having a cash ISA and a stocks and shares ISA. The latter is, in essence, no different to regular online trading. So you will be exposed to the same risks as any trader on the market.

What is a Stocks and Shares ISA?

On that note, stocks and shares ISAs function just as any shares and stocks investment does. The main difference is that is not taxed up to a certain amount (£20,000). But the actual types of products that the typical stocks and shares ISA will invest in will likely include blue-chip companies, exchange-traded funds and things like corporate and government bonds.


Stocks & Shares ISA: How Does It Work? 📊

The two steps involved in setting up your stocks and shares ISA are:

Step 1 📖: Choosing your platform, which one?

When setting up your stocks and shares ISA process, you will need to take a few considerations into mind.

First off, make sure you choose a platform that is fully regulated, meaning that it has proper legal permission to operate particular ISA products. For instance, some of the online trading brokers available offer this, as well as certain banks. Note that, despite the fact that your ROI made from interest and any returns from the market are not being taxed by the British government, each of the platforms on the market will have its own separate pricing structures where they will ask you to pay a fee to use services.

In the majority of instances, what you pay will be set as a per cent of the amount of funds in your account (being invested) or as a fixed rate. Whatever option is best for you will depend on your circumstances and size of your funds. The per cent structure may be best suited to smaller investors, whereas a flat fee might be best for high net worth accounts.

In addition, users will also need to pay other regular fees that the financial markets demand. For instance, long-term traders will need to pay overnight fees in certain instances. Day traders are able to avoid this because they open and close a position inside of a single day. But regardless, there will be a cost for making each purchase — some brokers do not charge commissions for this for placing positions, but they will make up their fees in one way or the other. For those who charge commissions, you will be billed, for example, to open and close a position on Amazon stock.

With this in mind, you need to educate yourself on the cumulative costs of opening and closing trades in your portfolio.

Furthermore, make a note of any costs your platform charges for transferring funds from them to another provider. Some platforms charge for that, whilst others do not. And the final mention is to make sure that any platform you choose is protected by the Financial Services Compensation Scheme (FCSC). That scheme insures you for up to £50,000 in damages if that platform happens to go bankrupt.

Step 2 📖: Knowing what to invest in, how to pick?

We recommended the online trading courses above for the very reason that trading stocks is simple at first glance, but very complicated on the backend.

Do you really want to manage your investment portfolio, who are you gaining your financial advice from? There is always risk in life. This can be avoided. But being prudent when investing in the financial markets is easier said than done, unless you have a good wealth of experience and knowledge. There is no guarantee that you will be successful and profit. And although it is favourable to make a tax-free profit in our stocks and shares ISA, your losses could possibly outweigh any tax relief benefits.

With all of this in mind, you need to prudently consider what products you want to make an investment in, and whether it is better if you have somebody else do it on your behalf.

Stocks and shares ISAs 📖: The solo route

Okay, so you’ve chosen to go solo. In this situation, need to have a grounded awareness of how the financial markets function. You're not only looking into the value of the stock but the dynamics of the market and associated factors. Emotions often come into play with investing. If these are not controlled they can lead to major irrational choices that damage your portfolio in a short time period. 

When going solo, your platform will not give you explicit financial advice. But it will offer technical indicators, research and market news—some platforms employ social trading and other features. These can give you a slight edge. The DIY approach avoids the need to hire a human professional financial adviser.  It also vastly reduces the minimum amount of funds you have to invest in order to begin using the markets, which allows people to test things out and put very small capital to work.

Using fund managers 👨‍💼

But suppose it seems overwhelming to go solo, in that case you can opt for a fund manager to build an investment portfolio on your behalf. In principle, a fund manager is responsible for handling your asset allocations. You should never give all of the decision-making to anybody — your money is fundamentally yours, and you are responsible for how it is used. But these advisers can help you to know what instruments to go for, decide what proportion of money to allocate to what and when. But you will need to pay the premium.

One common way that fund managers will charge you will be as a certain per cent of your total investment amount in your fund which could be as low as 0.1% or as high as 1%. The more reputable the fund manager, the more often the charge, although there are exceptions particularly with mutual funds.


Is It Worth Using a Stocks and Shares ISA?

Whether you want to invest in the financial markets boils down to more than just the fee and structure details.

One question to know is what you want to centre your decisions around. For instance, you could believe that you have all of the aspects of your life handled well and you simply want to have a little bit more diversification just in case the British economy worsens and the value of your cash savings dwindles further. Something like a mutual fund or exchange-traded fund could be perfect.

If you are already in a situation where you are in debt, do not have a good income and are looking to aggressively make money as quickly as possible, then you may need to take a step back and start saving first.

Fees

Let’s get back down to the practicalities. Investment ISAs can have quite confusing fees and other surcharges that various platforms implement.

If you are going through the online platform route or using a fund, the first thing to keep an eye out for is custodial or platform fees. These will either be charged as fixed charges, which is very effective for higher net worths, or as a per cent of the total investment fund size. 

Other charges to be aware of are investment or sales fees—for instance, these can be commission free or even more than a tenner. These add up on top are yearly management costs for your fund manager, in the event that you’ve used a human financial adviser.

One way to get a feel for whether your platform is giving reasonable rates is to compare it to others. Charges can also change over time, so make sure that your platform is still giving you a good deal compared to when you first opened the account. We also mentioned that you can change your ISA provider, which could incur fees for making that exit. If using a human financial adviser, they may charge you a trailing fee—this means that you are still paying your original adviser even if you switch to a new one.

The trailing fee can be, in some cases, eliminated if you make the prerequisite changes to your underlying investment structure or amount. Cash transfers happen when you sell all of your investments, giving any owed money to your old provider— while this is the fastest method, it can mean you lose out on gains that happen during your exit.

Capital Gains Tax

British people who make any profits on online investments need to pay capital gains taxes. These include things like stocks and shares or even real estate. The amount of capital gains tax you pay is decided by how much profit you make in your investment or sale.

Capital Gains Tax

As an example, suppose that you bought £10,000 worth of shares that you later sold for £20,000, then you will have to pay capital gains taxes of that ten thousand, based on your profits. Recent capital gains windows were set to £11,700 which are tax-free before you have to pay any capital gains tax. In this way, would get no benefit from using stocks and shares ISA compared to a normal online trading app unless you are predictably earning more than £11,700 from your stocks and shares investments.

A stocks and shares ISA will only give you an advantage if you were to earn more than that amount of money during a tax window.

Dividends

In the event that you push the shares in blue-chip firms, you may be able to make a profit in the form of capital gains as well as dividends.

Dividends are paid out to shareholders as a way of incentivising and awarding their investment. How much shareholders receive is related to the proportion of profit the company makes. In Britain, investors are able to make as much as £2k in dividends before they are taxed.

 

In Britain, citizens are allowed to make up to £2,000 in dividends before they are liable for tax.

 

After you go over that amount, your earnings become taxable, and you will be taxed according to your current tax bracket. However, since 2017, there has been no tax on dividends received from stocks and shares ISAs.

ISAs long-term 🏝️

So why do some people use stocks and shares ISAs? In truth, it’s probably the case that the majority of those who want to use this vehicle sensibly will need to be prepared to hold an investment over the long run. Particularly now, the volatility in financial markets makes it very hard to do any kind of short-term timing. Unless you are an experienced trader with multiple years of practice and working an effective strategy. This means that the optimal way to make ROI gains is to ride out the short-term fluctuations.  

Despite the fact that, historically, savvy holding of stocks long-term outcompetes the ROI gained from ISA savings accounts, though absolutely no guarantees that your investment will be savvy. There is no way to know either way, so any stocks and shares investment can go either direction.

One financial adviser, Martin Lewis at the Money Saving Expert, personally recommends that people with a sensible strategy hold onto their stocks and shares ISA for a minimum of five years.

However, if you believe that you will need to access your funds inside of those five years, then it might be more sensible to opt for a cash ISA. keep in mind that you are allowed to withdraw your savings at any point. Nonetheless, the annual limit you have is not reset. This means that if, for instance, you invested £10,000 into a stocks and shares ISA in the 2022/23 tax year and then withdrew it in that same year, this would leave you with only £10,000.


FAQs 📚

Are Stocks and Shares ISAs Worthwhile?

Ultimately, if you are happy to leave your money untouched for multiple years, then a stocks and shares ISA can give you superior benefits to cash ISAs.

What’s the Maximum Number of Stocks and Shares ISAs I can have?

It’s fine to own several stocks and shares ISAs. However, you can only pour money into each once every tax year. And the total contribution for each fund is set to £20,000. You can split this between investment and cash accounts. You can also have previous accounts from earlier financial years, however, you can only pay into a single fund for the current tax year. 

Keep in mind that the interest rates, surcharges and fees can vary. So look at the best deal for that current financial year so that you don’t end up paying more money and earning less interest. 

How Can I Set up a Stocks and Shares ISA?

Your ISA provider will ask for your date of birth, address, nationality, national insurance number and phone number. You are also be asked for proof of address and ID. After this, you are verified and your account is live. This can be set up at any point during the financial year.

How Does the FCS Protect Money in My ISA?

The FCSC covers any funds held in your stocks and shares ISA up to a total of £50,000, in the event that your broker goes into the fort or there is some criminal activity. You are, of course, not protected if your investment decisions lead to a loss.

Whatever Return Do Stocks and Shares ISAs have?

On average, stocks and shares ISAs have performed well. There are a few average rates of return for these account types over the last decade (9.64%: Source: fool.co.uk).

Average return on stocks and ISA

Stocks and shares ISAs – Closing Thoughts 📘

To conclude, investing in stocks and shares ISAs is a highly personal decision based on your circumstances and goals.

They can save cash tax-free up to £20,000. But keep in mind that Britain already gives tax-free incentives for capital gains and dividends are up to a certain figure, which means you may not actually profit from an ISA unless you go over that ROI.

A last note, remember that a stocks and shares ISA has the same risks as investments in traditional financial markets. It might be tax-free, but there’s no guarantee of not losing money or profiting.