10 things you need to know about ISAs
Picking an individual savings allowance (ISA) account in which to squirrel away spare cash can seem a daunting task when faced with the everincreasing range of options.
So as a starting point, make sure you understand the rules to ensure you choose the right account to suit you.
Here, we answer your top 10 questions about ISAs.
ONE: WHAT IS AN ISA AND WHO IS ELIGIBLE?
An ISA is a tax-efficient 'wrapper' in which you can hold cash or stocks and shares, and they make a great starting point for your savings because any interest earned on cash and any capital gains made on investments within these accounts are tax-free.
Higher-rate taxpayers also get income tax benefits from investing in a stocks and shares ISA. This is because they don't have to pay tax on any dividends they earn from this type of ISA. If they haven't got an ISA wrapper they'd have to pay 32.5% dividend tax, bar the initial 10% tax deducted.
Basic-rate taxpayers, however, pay the same 10% rate in or out of an ISA. If you want to open a stocks and shares ISA you have to be aged 18 or over, whereas you can open a cash ISA when you turn 16. You also have to be resident in the UK for tax purposes, and you cannot hold an ISA jointly with, or on behalf of, anyone else.
TWO: WHAT ARE THE YEARLY LIMITS FOR ISAS?
Each of us has an ISA allowance every tax year, but if you don't use it before 5 April each tax year, you will lose it. For this tax year (2013/14), you can set aside up to £11,520, of which half (£5,760) can be held in a cash ISA.
The full limit for each tax year can be placed in stocks and shares, but not wholly in cash.
THREE: WHAT TYPES OF DIFFERENT ISAS ARE THERE?
There are two different types of ISA - cash, and stocks and shares.
A cash ISA is basically a bank or building society savings account, with the difference that it enables you to earn interest tax-free. There are several types of cash ISAs available, including instant-access, fixed-rate and regular savings accounts, and which is right for you will depend on your circumstances.
An instant-access ISA enables you to put your money away, safe in the knowledge that you can withdraw it at any time should you need it.
Meanwhile, if you have a medium-term goal for your money, then a fixed-rate cash ISA is an option. Using this route, you'll tie up your savings for, say, between one and five years - but in return you'll benefit from a higher rate of interest.
The second type of ISA is a stocks and shares ISA, also known as an equity ISA. It can hold a range of funds, individual stocks and shares, as well as government and corporate bonds.
This type of ISA carries more risk because your return isn't guaranteed, and you may even lose money. However, the advantage is that you may receive higher returns over time by taking a greater risk.
FOUR: I PAY BASIC-RATE TAX. SHOULD I GET A STOCKS AND SHARES ISA?
"While gains from stocks and shares ISAs aren't subject to capital gains tax (CGT), most people don't pay CGT anyway, and it is only higher-rate taxpayers who benefit with regard to income tax," says Patrick Connolly, spokesperson for IFA AWD Chase de Vere.
But, even so, if there is no extra cost of holding your investments within an ISA wrapper, then it is sensible for basic-rate taxpayers to do so. Tax rules might change in the future, or you might become a higher-rate taxpayer, or your investments might perform well, so CGT could crop up as an issue.
FIVE: WHAT KIND OF ISA IS SUITABLE FOR ME?
This will depend on your attitude to risk and timescale.
For example, if you're using the money as a 'rainy-day fund' that you may need instant access to, an easy access ISA may be best.
However, if it's purely saving towards retirement, or a long-term goal, stocks and shares may prove more attractive for potentially greater returns.
SIX: HOW MUCH WILL ISAS COST ME?
You don't have to pay anything to open a cash ISA - the only thing you need to consider is to find one with a competitive rate, so do shop around. Many cash ISAs come with bonuses that expire after a year, so also be sure to move your money once the rate drops.
For a stocks and shares ISA, you generally have to pay a set-up fee and an annual charge. The best way to buy investments in an ISA wrapper is through a fund supermarket or discount broker. These offer a range of products and discount initial and annual fund charges, making it a much cheaper way to invest.
Some companies also reduce their rates in the run-up to the end of the tax year, so, again, shop around before you decide.
SEVEN: MY RATE HAD DROPPED, CAN I TRANSFER TO ANOTHER ISA?
Many ISA accounts will accept 'transfers in', which means you can move your money without losing the tax break.
But, beware, if you close your existing ISA without using a transfer and then look to move the money into another account you will lose this tax break and the money will count towards this year's allowance.
While you can't switch from stocks and shares to cash – unless you close the account and lose the tax break – you can move money from a cash ISA into a stocks and shares ISA.
EIGHT: IS THERE AN ISA FOR KIDS?
Yes. In November 2011, the government launched junior ISAs, or JISAs, to replace the child trust fund (CTF), which was abolished earlier that year. Like regular ISAs, there are cash and investment JISAs to choose between. The annual allowance is £3,600.
Children under the age of 18 are eligible to open one as long as they don't already have a CTF.
NINE: CAN I MOVE MY INVESTMENT INTO AN ISA?
If you hold shares or funds in an investment account, you can sell them and reinvest the proceeds in an ISA. This is known as 'Bed & ISA'. This way, you use existing money or investments to take advantage of annual tax allowances rather than having to find new money, which may not be available.
You have to use this route as you cannot transfer existing holdings directly into your ISA. So you need to sell them in one transaction, and then buy them back in another, through a tax-efficient ISA. However, this approach will only work for some investors, and there are likely to be transaction costs involved so seek advice before proceeding.
TEN: CAN ISAS FORM PART OF MY PENSION PLANNING?
It's sensible to create a diversified portfolio to save towards retirement. This can include pensions and other tax-efficient investments such as ISAs. With both cash and shares ISAs, you can get at your money as and when you want, unlike pensions.
Pensions provide initial tax relief, which is particular helpful for higher-rate taxpayers, but they are inflexible compared with ISAs.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Regular savings accounts
The attraction of these accounts is the high interest rate they pay. They require customers to deposit money each month, without fail. They come with a number of restrictions, such as monthly deposit limits, no one-off lump sum deposits and restricted withdrawal facilities. Although they are marketed with impressive-looking rates, it’s important to remember that as your money builds up gradually, your overall return will be lower than if you’d deposited a lump sum.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.