How to avoid a tax bill on Isa transfers

Moving funds can be tricky, but it should not put you off getting a better deal, writes Esther Shaw

Isas are making a comeback. While savers spent years putting up with rock bottom rates, cash Isas fell out of favour, as the interest they offered was even worse than those of standard savings accounts.

But as interest rates have risen the need for these tax wrappers has re-emerged as more and more people are in danger of getting a tax bill on their savings interest.

The personal savings allowance (PSA) has remained unchanged since it was introduced in April 2016, giving basic rate taxpayers £1,000 of tax-free interest per year (dropping to £500 for higher-rate taxpayers).

Stocks and shares Isas have also become more attractive, since tax-free allowances for capital gains and dividend tax were slashed this year – with further cuts to come in 2024.

It’s important to ensure your tax-free savings and investments are working as hard as possible – and if you spot a provider offering a better deal or service than your current one, you are allowed to switch without affecting your current Isa allowance. However, Isa transfers can be tricky. Telegraph Money explains how it’s done.

WHY MIGHT YOU WANT TO MAKE AN ISA TRANSFER?

One of the main reasons people transfer their Isa is to secure a better return.

Alice Haine, of broker Bestinvest, said: “If you have already paid into an Isa in the current tax year and want to take advantage of a higher rate, the only way to do this is with a ‘ transfer’.”

Transferring an Isa ensures your savings maintain their tax-free status without you facing any levy on your income or capital gain.

“If you withdraw funds and then re-save or re-invest them in a new Isa, this could use up your £20,000 annual allowance, and put you at risk of exceeding it. Transferring prevents this from happening as the funds remain under the protection of the tax wrapper. The £20,000 limit only applies to money paid in from outside an Isa.”

Another reason to transfer might be to consolidate multiple investment pots.

STEP-BY- STEP: HOW TO TRANSFER A CASH ISA

To avoid losing the tax- free status of your savings, you need to follow the transfer rules.

First, you need to find the Isa provider you want to move to and initiate the transfer through that firm.

Ms Haine said: “Note that some Isa providers don’t accept transfers, and some won’t allow a partial transfer out, insisting all funds are moved and the account closed.”

Once you’re ready to proceed, you will need to complete the new provider’s Isa transfer form.

You can transfer a cash Isa as many times as you want during the tax year, and transferring from one cash Isa to another should take no more than 15 working days.

Sarah Coles, of the broker Hargreaves Lansdown, warned: “If you want to move a fixed-term account before maturity, you will have to pay a penalty so calculate whether the penalty cancels out any benefit from the move.”

HOW TO TRANSFER A STOCKS AND SHARES ISA

If you want to move a stocks and shares Isa, the process is similar – but it can take up to 30 days.

As before, you need to contact your chosen new provider and complete a transfer request form.

Typically, transfers between stocks and shares Isas are “cash transfers”. This is where the current underlying holdings within the Isa are sold before the cash proceeds are then transferred to the new one.

Alternatively, you can have an “in specie” transfer. Clare McCarthy, chartered financial planner of the Private Office, said: “This is where all your current underlying holdings are moved between Isa providers without being sold to cash.”

While an in-specie transfer helps to avoid any “out of market” period, and can help cut ongoing fees, this type of transfer can take a matter of months because the underlying holdings needing to be “re-registered” with the new Isa provider. Ms McCarthy added: “During this period, changes to the Isa usually can’t be made, which could prove challenging if you wanted to withdraw money.” You should also check whether your provider charges fees to transfer out. Ms Coles said: “In some cases when transferring ‘in specie’ the provider will charge a separate fee for each investment you transfer. If this is the case, you might want to think about consolidating your investments to cut the costs.”

DOES TRANSFERRING COME WITH ANY PITFALLS?

Anna Bowes, of Savings Champion, said: “The key thing to remember is that if you want to move the money you’ve invested in an Isa during the current tax year, you must move all of it. For money you have invested in previous years, you can choose whether to transfer all or part of your savings.”

Failing to transfer all of the current year’s money will mean you’ll pay into two of the same type of Isa in the same tax year, which isn’t permitted. While you can contribute to all four types of Isa a year (cash, stocks and shares, Lifetime Isa, or innovative finance Isa), you can only pay into one of each type.

However, to complicate matters, thanks to another set of rule changes, a small group of providers will allow you to open several different types of cash Isa. These are known as Portfolio Isas.

WHAT ELSE DO I NEED TO KNOW? When it comes to Isas, you need to be aware that rule changes have been made relating to how you can use the money held within these wrappers.

Previously, if you made a withdrawal, you could not put that money back in without it counting towards your current annual Isa subscription

However, the rules have changed and some providers will let you take money out and replace it within the same year without adding to your allowance.

Ms Bowes said: “The Isa you are withdrawing from must be a ‘flexible Isa’ – and not all of them are. If you think there’s a chance you’ll want to make any withdrawals be sure to check.”

In addition, if you’re looking to transfer funds from a Lifetime Isa, you need to tread especially carefully as there are complicated rules you must adhere to. This includes only using the fund for specific goals – either buying your first home, or funding your retirement.

‘If you withdraw funds and then re-save or re-invest them, this could use up your annual allowance’