September 30, 2022

ISA warning: don’t lose your tax-free allowance by making this rookie mistake

With the end of the tax year edging nearer, did you know your ISA could lose its entire tax-free status if you fall foul of...
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The ISA deadline is now less than two weeks away. After 5 April, you’ll no longer be able to use your £20,000 tax-free allowance for 2021/22.

So, with time running out to max your tax-free limit, it’s also worth bearing in mind another very important ISA rule. If you don’t, your ISA could lose its entire tax-free status. Here’s what you need to know.


What’s the situation with the ISA deadline?

If you have a stocks and shares ISA – or any other type of ISA – then you only have days left to use up your annual ISA allowance for the current tax year. While you’ll get a brand new £20,000 limit from 6 April, you won’t be able to roll over any portion of the allowance you didn’t use for 2021/22.

In brief, the annual tax-free ISA allowance is the maximum you can put into an ISA in any given tax year. Anything stashed into an ISA stays tax-free, year after year. This tax-free status also covers interest and dividends.

So, stash £20,000 into a stocks and shares ISA and, if your portfolio rises by 5% in a year’s time, you won’t have to pay tax on your £1,000 profit. You won’t pay tax on any return you earn in subsequent tax years either. However, this only applies if your investment stays within an ISA wrapper.

What is the rookie ISA mistake to avoid?

ISAs are pretty flexible by nature. That’s because you’re allowed to change your stocks and shares ISA into a cash ISA, and vice versa. This can be very useful, particularly if your financial goals change.

For example, if you’re nearing retirement age, then you might be inclined to move your wealth held in a stocks and shares ISA into a risk-free cash ISA. Similarly, if you’ve become fed up with rock-bottom cash ISA rates, then you may wish to seek higher returns via a stocks and shares ISA.

However, aside from being aware of any exit fees that your provider could charge you, if you’re looking to change to a different type of ISA, then it’s vital that you tell your current provider that you wish to ‘transfer‘ your ISA, rather than withdrawing funds yourself.

While it might seem arbitrary, withdrawing funds is a rookie mistake, and it will see your ISA lose its entire tax-free status. This includes tax-free allowances from years gone by. In other words, anything you withdraw from your ISA instantly loses its tax-free wrapper. 

Of course, while you can open another ISA after making a withdrawal, you’ll be limited to what you can put into your new ISA by the annual tax-free limit. This could be a problem if the wealth you have in your ISA exceeds £20,000. 

For more on the process you need to follow to keep your ISA’s tax-free status, take a look at our article that explains how to transfer an ISA.


What else should you know about ISAs?

If you’re thinking of opening or contributing to an ISA before the tax year ends, then there are a number of potential pitfalls to bear in mind. Perhaps the biggest potential hazard is running out of time to open an account, especially if you leave it until the last minute.

Choosing investments in a hurry is another danger to be aware of. That’s because if you rush to open an ISA before 5 April, you could make an investment decision that doesn’t align with your investing style.

To reduce the risk of this happening, it’s worth taking The Motley Fool’s risk assessment quiz ahead of 5 April. That’s because your answers will help determine your appetite for risk, which might make it easier for you to choose suitable investments.

For more ISA need-to-knows, take a look at our article that explores five pitfalls to avoid before opening a stocks and shares ISA.

Please note that tax treatment depends on your individual circumstances and may be subject to change in the future. The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

The post ISA warning: don’t lose your tax-free allowance by making this rookie mistake appeared first on The Motley Fool UK.

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