The main thing that makes ISAs popular is their tax perks. Let's take a look at how they work.
Is an ISA tax-free?
Yes! You don’t need to pay tax on income from ISA investments, or capital gains tax on the profits you make from buying and selling ISA investments.
You also don’t need to pay tax on ISA withdrawals – regardless of whether they’re made up of dividends, interest or cash generated by selling investments.
The ISA allowance isn’t unlimited, but it is generous. You can save up to £20,000 of new money into ISAs each tax year, meaning you can build up a substantial tax-free pot if you keep it up over the long term.
Another perk is that ISA income, as well as profits you make on ISA investments, doesn’t need to be included on a UK tax return.
How ISA income works
Because ISA withdrawals are tax free, they can be an ideal way to generate income to supplement pensions or other income you earn.
Assuming a 4% dividend yield, you’d need a pot of £750,000 to generate a tax-free annual income of £30,000 from an ISA without eroding the value of your investments. On the same yield, you could also generate an annual income of £20,000 from a pot of £500,000, and could take £10,000 tax free a year from a fund worth £250,000.
Assuming you put the maximum ISA allowance of £20,000 into your ISA each year and a 5% investment return each year after fees, here’s how long it would take to reach those same pot sizes:
| Annual income | Pot needed | Years to reach pot | Final ISA amount |
|---|---|---|---|
| £10,000 | £250,000 | 10 | £264,136 |
| £20,000 | £500,000 | 16 | £496,807 |
| £30,000 | £750,000 | 21 | £750,104 |
Source: AJ Bell. Assumes a 4% yield for income, 5% total return after fees for growth of pot, and full £20,000 ISA subscription every year.
Will ISAs ever be taxed?
If you break the ISA allowance rules – by paying in more than your total allowance – the income and gains you make on the excess cash and investments might be subject to tax.
Learn more about managing multiple ISA accounts
ISAs do form part of your estate when you die, meaning they could be subject to inheritance tax depending on the value of your other assets.
And don’t forget that Lifetime ISAs have their own withdrawal rules. Though not an ISA tax, you’ll pay a 25% withdrawal charge if you take money out of a Lifetime ISA before age 60, unless it’s to buy a first home.
Important information: Remember that investments go up and down in value, and you could lose money as well as make it. How you’re taxed will depend on your circumstances, and ISA and tax rules can change. We don’t offer investment advice, so you’ll need be confident you can manage your ISA yourself. These articles are for information purposes only and are not a personal recommendation or advice.
An AJ Bell Stocks and shares ISA is an easy, efficient way to invest. It’s completely tax free, so more of what you make stays in your pocket.
No matter where you are in your investing journey, our learn hub is here to help you feel good, investing.
Written by:
Charlene Young
Charlene Young is AJ Bell’s Pensions and Savings Expert. She joined AJ Bell from a wealth management firm where she worked with private clients and small businesses as a financial planner. Charlene holds Chartered Financial Planner status and is an associate member of the Society of Trust and Estate Practitioners (STEP).
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