Savings experts debunk common ISA myths to help savers 'make the most' out of accounts

With frozen allowances and high interest rates dragging more savers into the tax net, many are turning to ISAs as a tax-efficient option to invest their money. 

Shawbrook Bank has seen a staggering 73 percent increase in new cash ISA accounts from January to May 2023 compared to the same period last year. 

While these accounts remain a popular savings option amongst Britons, there are a few misconceptions about how they work.

Rob Morgan, chief investment analyst at wealth management firm Charles Stanley, said: “ISAs are a popular way for consumers to build up tax-efficient savings and investments, as they are sheltered from paying capital gains or any further income tax. And if you look at the potential compounding effects of long-term savings, the returns can amount to quite a substantial nest egg.

“But despite their popularity and having existed for more than two decades, there is clearly much confusion about how they work.

“This brings into question whether consumers are making the most of their ISAs, but also if they understand what other tax efficient savings vehicles there are to utilise, such as pensions.”

According to research by Charles Stanley, nearly three-quarters (74 percent) don’t know what a flexible ISA is, with more than a quarter (27 percent) having never heard of one. Up to 11 percent think a flexible ISA it allows people to increase their ISA contribution, while 20 percent think it allows them to swap their cash ISA to a stocks and shares ISA or vice versa. Nine percent think it allows them to transfer their ISA to someone else.

Based on research gathered by the wealth management firm on the most common ISA misconceptions, Express Money spoke to experts to find out the rules. 

People can only have one ISA at a time – 19 percent

Up to 19 percent of survey respondents believe people can only have one ISA at a time. 

Rowan Harding, financial planner at Path Financial told Express.co.uk that people can have, in theory, as many ISAs as they want and spread their £20,000 tax-free personal allowance across these. 

However, he noted: “There are limits placed on certain ISAs. For example, you can only invest in one Stocks and Shares ISA or Innovative Finance ISA each year, but you can open a new ISA with a different provider each year.

“You have the flexibility to split your tax-free allowance across as many ISAs and ISA types as you wish. For example, you may invest £10,000 in a Stocks and Shares ISA and the remaining £10,000 in a Cash ISA. This is a useful option for those who want to use their investment for different purposes and over varying periods of time.” 

ISA allowance top-ups from previous years’ unfulfilled contributions are allowed – 16 percent

Up to 16 percent of savers are confused about the annual contribution rules of ISAs, most pertinently thinking they can use last year’s allowance to save even more tax-free this year.

Alister Sneddon, head of product at CMC Invest told Express.co.uk: “Your allowance is ‘use it or lose it’ – you can’t carry forward previous years’ unused contributions. 

“It can be scary to deposit larger amounts into your ISA and fear you are locking away your money, but these days you can get flexible options to ensure it’s easy to access your money when you need it to encourage you to maximise the annual allowance.”

People can’t take withdraw money from an ISA – 11 percent

Up to 11 percent of respondents believe you cannot remove money from an ISA once it’s invested, but this is incorrect. 

Mr Sneddon said: “Most ISAs will allow you access to your money, but you might face penalties on interest rates or returns from your providers.”

Some providers offer “flexible” ISAs that not only allow withdrawals but also enable savers to replace the money without losing any of their annual allowance.

Mr Sneddon said: “It’s an excellent way to maximise your allowance, easily access your cash when you need it, and easily replace the money back into the ISA before the end of the tax year. 

“These flexible rules apply to all the cash in your ISA, this means if you have £50,000 in your ISA and a £20,000 unused allowance, you can withdraw £15,000 and deposit £35,000 into your ISA that year. The flexible nature makes this fantastic for purchases which might not be guaranteed or if you want some assurances around how and when you can access your cash.”

An ISA is the only tax-efficient savings option – 17 percent

Up to 17 percent of savers believe ISAs are the only tax efficient savings option.

While ISAs are often the first port of call for investors looking to save tax, pensions are “more tax efficient than ISAs” for many people, experts at Charles Stanley have said. 

Charles Stanley said: “You get a boost to your own payments in through tax relief plus there’s no tax on gains or income on investments in a pension. While there can be tax to pay when you take money out, and you have to wait until retirement age to do so, they tend to be highly advantageous for those investing for a comfortable retirement.”

People get taxed on any interest earned within an ISA – nine percent

Nine percent of people believe interest earned within an ISA gets taxed. 

Charles Stanley said: “Interest paid on cash in ISAs is tax free. Similarly, any income received from investments such as dividends from shares isn’t taxable, and there is no capital gains tax to pay on profits.”