What is an ISA?
An Individual Savings Account (ISA) is a wrapper around a savings account or investment that has tax advantages.
What are the different types?
There are two types: a cash ISA or a stocks and shares ISA.
What is a cash ISA?
It is a savings account with the tax-free ISA “wrapper” placed around it so that you earn interest tax-free. Depending on the type of account you choose, you can have access to your money or tie it up until a future date – the latter tend to earn greater interest than the former – just like typical savings accounts.
They are considered low-risk as you will not lose your cash unless the savings provider goes bust – even then you’ll be protected by the Financial Services Compensation Scheme to the tune of £85,000 per person, per organISAtion.
What is a stocks and shares ISA?
A stocks and shares ISA is a stockmarket linked investment, where you wrap your tax-efficient ISA around an investment product such as shares, bonds, funds or investment trusts.
They are higher risk because investments can go down as well as up, meaning you could lose money. This is why they are better-suited to longer-term investors.
How much can I put in an ISA?
Every tax year you are entitled to a new ISA allowance. For 2013/14 this is £11,520. You can invest the whole amount in a stocks and shares ISA or you can split it by investing a maximum £5,760 in a cash ISA.
What are the tax advantages?
Interest is paid tax-free on a cash ISA, while any profits you make on a stocks and shares ISA are free of capital gains tax.
The income you receive from a stocks and shares ISA is a little more complicated. Although a 10% tax credit is automatically deducted, there is no further tax to pay on dividends.
This means that, while higher- and additional-rate taxpayers are better off in an ISA (as they would otherwise pay 32.5% or 42.5% respectively), basic-rate taxpayers would receive exactly the same amount of money whether their investment was inside or outside the ISA wrapper.
The exception is when income is derived from bonds or other fixed-interest investments, as this is classed as interest and paid tax-free in the same way interest is paid on a cash ISA.
What charges will I pay?
Cash ISAs tend to have no explicit charges – just like savings accounts – though you may face penalties if you withdraw cash from an ISA where you have agreed to tie your money up.
Charges on stocks and shares ISAs depend on your choice of account and how you invest the money. While you may be hit with an initial and an annual charge of between 0.5% and 5.5% on a fund-based ISA, if you have a self-select ISA (where you choose the assets you want to hold, rather than a fund manager making the decisions for you) you could face dealing charges and stamp duty on shares and an annual plan fee.
Can I transfer one ISA to another?
Yes, but you must stick to the rules. The simplest way to transfer is to ask your new ISA manager to do it for you. You'll need to complete an application form to open an ISA with it as well as a transfer request form. It will then contact your existing ISA manager and arrange for the funds to be transferred to your new ISA.
You also need to abide by the rules on what you can transfer. While you can shift all or some of a previous year's ISA allowance, because you can only have one cash and one stocks and shares ISA in the current tax year, you must move all of it.
It's also possible to transfer your cash ISA to a stocks and shares ISA if you decide this is a better home for the money. The transfer process is exactly the same but do remember that once in stocks and shares you can't switch the money back to a cash ISA.
Who can have an ISA?
Any UK resident can open a cash ISA from the age of 16 and a stocks and shares ISA from the age of 18.
Where can I get one?
You can walk straight into a bank or building society branch and open an ISA, or open one over the phone or online if the provider allows.
You can also buy a stocks and shares ISA direct from a fund management company or via a broker or fund platform. You’ll need proof of identity such as a passport or utility bill.
What should I use my ISA for?
You can treat it merely as a tax efficient savings account, should you wish. But you’ll earn more money if you lock your savings away for more than a year (the longer you invest it, the higher the rate).
But many people invest in the stocks and shares version in order to generate a better return. You can invest in most types of investment including: shares listed on recognized global stock exchanges; UK and European gilts; corporate bonds; investment trusts; funds; and exchange traded funds.
This makes them ideal for longer term savings goals such as boosting your retirement income.
Sometimes known as a trading ISA, a self-select ISA gives investors full control over which assets to include in their ISA, allowing them to choose individual shares and bonds rather than investment funds. Aimed mainly at experienced investors and subject to the same investment limits of a regular ISA, a self-select ISA will usually be managed by a stockbroker on an investor’s behalf.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
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.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
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.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
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.
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.