What is a stocks & shares ISA and how does it work?

A stocks and shares ISA is effectively a tax wrapper that protects an investor’s account from taxes, such as stamp duty and capital gains, and dividend allowances. Unlike standard cash ISAs that have a minimum age requirement of 16, an investor needs to be 18 years old or older to open a stocks and shares ISA. Some providers offer junior accounts for those under 18, but rules stipulate that these must be opened by a parent or legal guardian.

The annual ISA saving and investing allowance is expected to be frozen at £20,000 in 2022 and 2023, which will mark the sixth year in a row that it has been held at this rate. The freeze has been criticised by some, but it’s still considerably higher than the £11,280 savers were allowed to put away in the 2012/2013 tax year.

The allowance can be spread across multiple ISAs, including cash ISAs, stocks and shares ISAs, and innovative finance ISAs. However, you can only pay into one of each type in a single tax year; you wouldn’t be able to contribute to two stocks and shares ISA accounts in one tax year.

A stocks and shares ISA account is like investing in the market through a general investment account. You can buy into individual companies as well as a range of exchanged-traded funds​ (ETFs) and investment trusts. The only difference is you won’t have to pay capital gains tax or declare any income or interest on a tax return.

There are different types of stocks and shares ISAs, but the main differences are related to who can invest in them and when they can withdraw.

This is a normal stocks and shares ISA that gives you the ability to invest in stocks​ and ETF from around the world with tax-free allowance. You can withdraw from your stocks and shares ISA without facing extra charges.

A junior stocks and shares ISA account can be opened and managed by either a parent or legal guardian or when the child turns 16-years-old. Once the child turns 18, the junior ISA can convert to an adult ISA. At this point, they take control of their cash and decide whether the account should be rolled over to a full stocks and shares ISA.

A lifetime stocks and shares ISA can be opened between the ages of 18 and 39. For every £4 invested, the government will add £1. You can put in up to £4,000 in a single tax year, meaning the government can pay you up to £1,000. Money can be put in up until the age of 50, but you must either use it to buy a property worth up to £450,000 or wait until you’re 60 to access the savings.

Some investors may prefer a stocks and shares ISA over a general investment account as you can buy and sell assets without having to worry about whether you’re going to exceed the capital disposals limit.

The capital gains allowance for the tax years 2022/2023 is £12,300 outside a stocks and shares ISA. This means that if you had a general investment account set-up, exceeding the allowance by just £1 means needing to declare the profit to HMRC. There’s also a lesser-known rule that you need to report capital gains if the total amount you disposed of from sales in a tax year is four times the limit or more — £49,200. This is the case, even if you’ve made a loss.

Just like any investment account, the provider will need your address, date of birth, phone number and national insurance number. You need to be a UK resident to open any type of ISA account.

Some providers will use a credit reference agency to automatically verify your identity. Others may request a copy of an identification document along with proof of address.

Typically, you can choose from hundreds of UK-listed and US-listed stocks to invest in. Some providers will offer European-listed and Asian equities​ as well.

While there will also be a range of ETFs to pick from, UK investors may struggle to buy funds managed by US investment funds, such as Ark Invest, for example. This is because many providers only grant access to ETF products that meet certain requirements, such as the publication of a key information document (KID), so a UK investor will typically be investing in UK based ETFs that are listed on the London Stock Exchange.

As with any investment in the market, it’s important to do your research first. Some providers have handy guides and tips on stock investing o get you started on your journey. Our Opto magazine​ also offers stock market updates, expert opinions, and interviews with investors.

It depends on your personal circumstances. Stocks and shares ISA providers tend to pay interest on any money deposited and held in the account rather than invested in the market. This is ideal for those with saving accounts that might be waiting for the right investment opportunity to come along.

Providers can often charge either:

A passive investing strategy​ could see returns of between 5% and 10% on average annually. For example, the average return for the UK stock market based on the FTSE 100 is about 7% and 8% per year. Meanwhile, the S&P 500 averages between 9% and 10% per year. However, remember that past performance is not a reliable indicator of future results.

This is, of course, far higher than any interest you’d get on any savings account, but are stocks and shares ISAs worth it? That depends on which investing strategies​ you use and your appetite for risk.

As with any investment in the market, there’s no guarantee that your stocks and shares ISAs is protected. Your money isn’t protected if a company’s share price drops in value and fails to recover.

Given the risk of your investment falling in value in the short term, stocks and shares ISAs may be well suited to those saving for the long-term and who don’t need access to their money in the near future.

It’s important to note, though, that savings up to £85,000 are covered by the Financial Services Compensation Scheme (FSCS) in the unlikely event that your provider becomes insolvent. You should contact your provider for more information on this.

You can open as many stocks and shares ISA accounts that you like over the course of your lifetime, but you’re restricted to contributing to one in every tax year.

A common misconception is that your money is locked into an ISA account once deposited, but this isn’t true for all. You can either make withdrawals, leave it as cash in your account or reinvest at a later date as long you don’t go over your annual allowance.

This means that you can take money out and reinvest it without affecting your annual allowance. For example, if you deposit £12,500 but later withdraw £2,500. Usually, you’d only have £7,500 left to invest to reach the maximum £20,000 investment. But with a flexible ISA account, you’d still be able to invest £10,000. Flexible accounts can be ideal for savers looking to put aside dividends.

You can transfer both cash ISAs and stocks and shares ISAs to other providers. Some may charge a transfer fee, however.

If you’re transferring a stocks and shares ISA, it’s best to check that the provider you want to move to allows you to trade the stocks, ETFs, and investment trusts that you already own.