Did you know that you can build up an ISA allowance without keeping the money in it?
Well, that’s Flexible ISA in a nutshell.
Flexible ISA is a fantastic tool for business owners because it allows us to move money in and out without losing the tax-free benefits.
I will also share a clever way to create a big ISA allowance (say £100,000) without having to invest the money.
First, let’s quickly cover the basics.
How a Standard ISA works – The Basics
A typical ISA allows you to invest £20,000 every tax year. This is your £20,000 annual allowance.
Your pot grows tax-free, as long as it remains inside the ISA.
But if you take any money out, then you lose that portion of your allowance permanently.
You cannot “put them back in”.
Every deposit uses up your allowance.
To put the money back in, you either have to eat into your remaining allowance, if any or otherwise wait until next year’s reset!
Typical (Non-Flexible) ISA Example
For example, say you opened a new ISA in the new tax year and put £20,000 in it. You cannot put any more until next year, since your allowance is used. Sometime in May, you take £5,000 out of this pot.
You cannot put this £5,000 back into your ISA. You’ll have to wait until April next year to deposit any new money, by using your next year’s £20k allowance.
In other words, your ISA from year 1 can only hold £15,000 of your own money (plus any shares appreciation). That’s bad.
The problem worsens if you have built a generous allowance over the years and have to use the funds to buy a house or something. You’d lose all these years’ allowances too. Ouch!
These restrictions apply to most ISAs, which is stupid if you ask me. All ISAs should be flexible.
A Flexible ISA solves this problem. Especially for business owners and limited company directors.
What is a Flexible ISA?
With a Flexible ISA, you don’t lose the equivalent allowance if you take money out of your ISA.
You can simply put them back in as long as you do it in the same tax year.
This illustration from Paragon who offers a flexible cash ISA is very useful:
Business owner example
For example, say you want to buy a house. Over the past 3 years, you have been maxing out your ISA and have accumulated £60,000 worth of investments.
You sell your stocks and put a £60,000 deposit. You now have until the end of the current tax year (April 5th) to replenish your ISA without having to lose all your allowance!
You could get a £60,000 director’s loan from your business on April 5th (just before the tax year ends), deposit it in the ISA, withdraw it on April 6th, and pay the business back.
This would keep your allowance intact even though no money is in it.
Neat.
This is why I believe a Flexible ISA is an amazing tool for limited company owners.
But I can think of other good scenarios too.
Note that with a director's loan, there can be tax implications for both the company and the director if the loan exceeds £10,000 or if it's not paid quickly as shown above. Your company may have to charge you interest on the loan (yes, even for 1 day). Check with your accountant before going down this path.
Who is the Flexible ISA for?
The Flexible ISA is great for you if you:
- Have an unstable income pattern (business owner or self-employed)
- Plan to sell your business
- Have an offset mortgage
- Take more dividends than you need just to top-up the ISA
- Plan to claim Entrepreneur’s Relief
- Await an inheritance
- Want to buy assets not available in an ISA (e.g Bitcoin) but keep your ISA allowance
As you can see, the Flexible ISA can work well for many different groups.
I’d like to dive deeper into two use cases.
Example #1: Selling your business or claiming Entrepreneur’s Relief
If you plan to sell your business in a few years, you can take advantage of the Flexible ISA to prepare a tax shelter for the sale proceeds.
Over the years you would be building up your allowance, growing your tax-free bucket.
Each year this grows by £20,000.
Year 1: £20,000
Year 2: £40,000
Year 3: £60,000
Year 4: £80,000
In Year 5, the business is sold.
£100k can now go into the ISA in one go and keep growing tax-free.
Example #2: Stop taking more dividends just to fund the ISA
I know many business owners who take more income out of their business, so they can just fund their ISA. They don’t want to lose the annual ISA allowance, understandably so.
But at the same time, they don’t enjoy paying higher taxes since they don’t really need the money.
So they find themselves in a pickle.
What do they do? They typically draw more dividends to fund their ISA, stepping into the high-rate tax territory. So their overall income is £70k, even if they only needed £50k to live on.
Or £120k, when they only needed £100k.
A flexible ISA solves this problem too.
Instead of paying a higher dividend tax (33.75% or 39.75%) to fund your ISA, you could build a flexible ISA allowance over time, while investing through your company instead. Or just keeping the money as cash in the business.
This can result in big tax savings over time.
As a result, you can secure your new ISA allowance without having to draw extra dividends from the business at a higher tax rate.
Here you could argue that not taking the dividends means lost opportunity cost in investment returns.
Because presumably, your ISA investments will grow, whereas your company cash won’t. I hear that. But there are options such as investing through your company or putting the money in a high-yield business bank account.
Flexible ISA with an offset mortgage: The perfect match
Like two communicating vessels, an offset mortgage is a perfect companion to a flexible ISA.
An offset mortgage is one where you can keep your mortgage equity in cash in your account, while the bank only charges interest on the remaining loan amount.
The offset account benefit is that you can access the cash anytime, without costly re-mortgaging processes.
Example:
- House price £500,000
- Deposit = £200,000
- Interest 5%
You would keep the £200,000 in cash in your mortgage bank account, and only be charged interest on the remaining £300,000. You can have access to the cash anytime and grow or reduce the loan amount as you see fit.
Basically, like standard mortgages, but better, because it gives you the flexibility to use your cash.
With a Flexible ISA, an offset mortgage can work very well.
You can keep the cash in your mortgage to reduce your interest while topping up your flexible ISA just before year-end. Then a day later, you would return the cash back to your offset account.
As a result, you pay down your mortgage while using the same funds to grow your ISA allowance each year.
Offset mortgages are harder to find and potentially more expensive as choices are limited.
The Best Flexible ISAs
Most Flexible ISAs are Cash ISAs, but Flexible Stocks and Shares ISAs do exist.
Here is a list of the best flexible stocks and share ISAs for business owners:
- Vanguard Flexible ISA
- Charles Stanley Flexible stocks and shares ISA
- BestInvest flexible ISA
- Eqi stocks and shares Flexible ISA
What I like to see:
Flexible Cash ISAs are offered by many more providers, usually banks. These include Barclays, Paragon, Coventry Building Society, Tesco, Lloyds, TSB and Chip Cash ISA.
Always check the terms, because you may not have unlimited withdrawals.
We can help each other with some crowdsourcing. If you know of a good Flexible ISA let me know and I can add them.
I hope this article helped you to understand the great benefits a Flexible ISA can have for business owners, but also everyone else. I also want to see more Flexible ISA options in the future.
Happy investing.