Breaking Isa transfer rules could trigger a tax bill – here’s how to avoid it

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, and involve some rules you need to follow to the letter. Here, 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. Ms Haine added: “Transferring several Isas into one place can help you keep tabs on the performance and value of your holdings, and ensure you don’t lose track of where your money is held.”

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: “As cash Isa rates are now much more competitive, be sure to hunt out the best deal to secure the best return. But 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. If the process is taking longer, ask your new provider what is causing the hold-up.

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. Before you do anything, it’s worth calculating whether the penalty cancels out any benefit from the move.”

Providers commonly charge between 30 and 120 days’ interest on the sum being withdrawn or moved before the account matures – in general, the longer the term the higher the penalty. If you’re only going to be gaining a small amount of interest then this loss may not be worth it.

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.

The new provider will use the cash proceeds to reinvest within the new stocks and shares Isa.

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 (when your cash isn’t invested), and can help reduce ongoing fees, this type of transfer can take a matter of months, due to 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, say, you wanted to withdraw money.”

You should also check whether your provider charges fees for you 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 before you switch to cut the costs. But you’ll need to calculate whether it’s worth it.”

Does transferring come with any pitfalls?

There are some extra rules to bear in mind before going ahead with any transfers.

Anna Bowes, of Savings Champion, said: “The key thing to remember, apart from approaching the new provider and asking them to arrange the transfer for you, 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 per year (cash, stocks and shares, Lifetime Isa, or innovative finance Isa), you can only pay into one of each type.

Ms Haine said: “That’s why transferring accounts is very important if you want to take advantage of better rates or a platform with lower fees. This will help you avoid the risk of contributing to more than one of the same type in the same tax year.”

This rule can catch people out in cases where they’ve opened a fixed-term Isa and deposited less than their full Isa allowance.

Ms Bowes said: “Once that fixed-term Isa closes, it can’t be topped up. In this case, the only way to maximise your allowance for that tax year is to open another type of Isa – so a stocks and shares Isa, for example – with a different provider.”

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

Ms Bowes added: “If you do open your Isas with a provider offering this feature, you should be able to deposit cash into a fixed-rate Isa and an easy-access Isa if you want to, without breaking the Isa rules.”

But not all providers allow this, so check carefully before proceeding.

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. For example, if you’d paid in £5,000 and withdrew £1,000, before later paying it back in, you’d be recorded as using £6,000 of your Isa allowance.

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. This applies both to an old Isa or your current tax year’s Isa.

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 within the same tax year, be sure to check.”

In addition, if you’re looking to transfer funds from a Lifetime Isa (Lisa), 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.

Ms Bowes said: “While you can transfer from one Lisa to another, if you transfer cash and assets from a Lisa to a different type of Isa before the age of 60, you’ll have to pay the withdrawal fee of 25pc.”