Moving money into ISA to avoid tax on savings

[SavetoSave]

So I know that you can save up to 20K a year tax-free in a Cash ISA. My question is, at what point is the tax calculated? Is it at the end of the tax year? Or when it's added to the account?

Can I save money in a higher interest rate account then move it to an ISA? I remember a Martin lewis blog saying this but I can't seem to find it. It was from 2016 and all the latest ones make no mention of timings.

https://www.moneysavingexpert.com/news/2023/03/martin-lewis-isa-warning/

You don't pay tax on any interest earned in an ISA (or income tax/CGT on investment ISAs).

For any other interest on savings (ie not in an ISA), I believe the personal allowance is £1000 or £500 annually depending on your rate of income tax. Any interest over this would be taxable.

So there's no calculation of tax in respect of ISA interest/growth.

How much interest will you earn? Depending on your income you could earn up to £1000 of interest and not pay tax on it.

Only the interest earned in the ISA is subject to the ISA rules - ie not taxed.

Interest earned on other accounts are taxed according, albeit subject to the savings allowance (£1,000 interest for basic rate tax payers, £500 for higher rate and nil for additional rate).

Can I save money in a higher interest rate account then move it to an ISA?

No. You will pay tax on the interest earned on the non-ISA account.

It's not about timing, it's about where and on what the interest is earned. The money has to be in an ISA wrapper to benefit from ISA treatment.

Interest paid at any point on a non-ISA is taxable.

Interest paid on an ISA is exempt. As long as you follow the ISA rules.

I found it!
https://www.moneysavingexpert.com/savings/flexible-isas/#:~:text=Here's%20how%3A,the%20process%20again%20and%20again.

1. At the start of the new tax year – so from 6 April – withdraw the ISA cash.
2. Put it in (several) high interest accounts (see our Top savings guide for the best deals).
3. Before 5 April the following year just put it back in the ISA to keep your tax protection.
4. Repeat the process again and again.

However, the HMRC forum says that:
https://community.hmrc.gov.uk/customerforums/pt/f58be9bc-b471-ed11-97b0-00155d9c7b3d

The bank which reports to HMRC how much you earned... at the time of paying interest (as some pay monthly, some annually) so if you earned the interest before moving the money then it would be liable for tax

Does that mean Martin Lewis is wrong?

@PiscesScot @folkjournals see above.

I believe, once you withdraw money from an ISA, it loses its ISA status. Why don't you look for an ISA with a good rate if interest? I think some are paying between 5% and 6% currently.

That's talking about how to preserve your annual allowance with an ISA - i.e. if you take money out of your ISA it doesn't eat into your allowance for the year. Otherwise the effect is you'd only have £18k allowance if you withdrew £2k.

You can't empty your ISA above the annual allowance and put it back in in one year. You can only add £20k in a year and you can only transfer between ISAs using the formal ISA transfer process if you want to retain the tax exempt status of the funds.

If your interest earned outside the ISA is below the savings allowance there'd be no tax, but you would have had that regardless of whether you put the capital into an ISA or not.

The UK has a self assessment system, so you are responsible for declaring all your taxable income to HMRC and paying the correct amount of tax.

If you earn interest outside an ISA wrapper, it is taxable. It may be covered by the savings allowance if low level, but it's still taxable if earned outside an ISA.

If you used your full ISA allowance each year, you could have £100k in an ISA wrapper after five years. All the interest earned on that ISA would be exempt.

If you took out the £100k, anything it earned elsewhere would be taxable AND you would only be able to put £20k back into your ISA that year so would have lost the tax exempt status on the other £80k and missed the chance to grow the fund.

The article is specifically about flexible ISAs (where you are allowed to move money out and back in, within the same tax year)

You have £5 in a flexi ISA
Withdraw it after the start of the new tax year and distribute between non ISA higher interest accounts (any interest made on this over your personal allowance is still taxable - I may have missed but don't think the article explicitly states this)

Before the end of the same tax year, move your original £5k back into the flexi ISA. When interest is calculated for the year on the ISA, THAT amount will remain tax-free

So for the majority of the year you could take advantage of higher interest rates in normal (non ISA) savings, but still earn tax free ISA interest on your original investment amount.

Those aren't flexible though.
This whole situation has only occurred because of the steep rise in interest rates. I'm a higher rate taxpayer so only get £500 tax-free savings allowance. I kept my emergency fund (about 10K) in an account that was previously paying a low level of interest but now it's hit 4%+ (and set to rise even more) I'm going to get close to the limit of my allowance, if not over.

If I put the money into a 'flexible' ISA then I lose out on my actual long-term savings being in an ISA with a good interest rate because you can only have one a tax year plus those have very strict rules on withdrawals.

I suppose, in the absence of an account that still pays a sub-3% interest rate I could just put the money in a current account. No interest, no tax.

That aside, I need to work out if taxed, how much it will be in the first place. Perhaps at a certain level of saving it will still be worth it. I'm in a very volatile industry - there's a high chance that at any point I could lose my job and take a few months to find another, especially now. That's why I need the money accessible. Obviously if it's sat in a current account the money loses value thanks to inflation anyway, but that has to be weighed against the cost of it actually leaving my account as tax.

Also, interest earned in the ISA gets added to the ISA, so the amount you end up with inside the ISA wrapper grows and therefore you'd have compound exempt interest income. Which you would miss out on if you used the capital to earn non-ISA interest.

As far as I can see, the "advice" you linked is only useful if you can't grow your ISA and you don't care about compound interest growth on the ISA you have.

More info as I wasn't 100% on being able to withdraw & return amounts over £20k:

It is even possible to withdraw the entire balance from your ISA, potentially worth several hundred thousand pounds, and replace it by 5 April. This can be done at no cost with your Charles Stanley Direct ISA as we don't charge for electronic BACs payments. It is important to note that if you fail to replace it by the end of the tax yearr_, you will lose the ability to return the balance to your ISA without impacting your annual allowance.

www.charles-stanley.co.uk/insights/commentary/flexible-isa-rules-some-isas-are-more-flexible-than-you-think

Ah OK, I see what you're saying.
From another perspective, the benefit of this is, an ISA is use it or lose it. So by returning the money to the ISA every year you preserve that amount of money for earning tax-free compound interest and, I suppose, you can even transfer the ISA (using the formal process) to ones paying a better interest rate.

However if the interest on savings is above the tax-free limit when outside the ISA it's a different problem altogether and cannot be circumvented by moving the money.

Thanks, this has been very helpful.

Thanks for the article, that's very useful!
There's a lot of juggling one can do with ISA's. It's quite interesting. I never had cause to look very closely at this with low interest rates (but also, pre-buying a house I had a LISA and focused on that, no room for other cash ISA's).

I've been thinking about this recently too. I think the important thing to remember is that even if you do get taxed on any interest, you're still getting some interest. I think the rate of tax is either 20 or 40% depending on your income.

Both ISAs and NS&I Premium bonds aren't taxed.

It's counted as extra income - say your current taxable income is 20K, with £100 taxable interest you then have £20100 of taxable income.