Will you be the next Isa millionaire?
The Isa season, refers to last-minute investing in the run-up to the end of the tax year on 5 April when if you haven't used your Isa allowance for the year, it is lost forever.
With investor confidence picking up and interest rates remaining stubbornly low, many experts are expecting a bumper year for stocks and shares Isas.
A return to equities has been gathering pace with this asset class continuing as the best-selling for the eighth successive month. More than £935 million was poured into them in November, according to the most recent figures from the Investment Management Association.
The dedicated investors who have managed to achieve the elusive £1 million Isa have been saving for years but it's not too late to get started. With a tax allowance of £15,240, we explore what you need to know to maximise your Isa.
Can I really be an Isa millionaire?
Using the current £15,240 Isa allowance as a starting base, assuming the allowance rises 2% each year and the annual capital growth is 5% after charges, a couple could see their Isa pot reach more than £1 million within 20 years, according to investment broker Chelsea Financial Services. With the same assumptions, an individual investing their full Isa allowance could see their investment reach £1 million in just 30 years.
Darius McDermott, managing director of Chelsea Financial Services, says: "Becoming a millionaire can seem an unachievable ambition for many but, as the figures show, it is actually well within the grasp of an individual who starts to invest regularly from age of 30 to 35, or a couple who begin investing from when they're between 40 and 45.
"What this then means is that at age 60 to 65 they could then start to enjoy an additional tax-free boost to their finances of around £50,000 a year, by either taking a 5% income from their investment (from dividends or bonds) or selling part of their investment free from capital gains tax. That's not a bad retirement pot to have."
Why invest in an Isa?
Holding money in an Isa is tax efficient because it avoids paying income tax and capital gains tax. Cash Isas are completely tax-free although stocks and shares (or equity) Isas attract some tax charges.
If you have investments outside an Isa, any share dividends you receive are liable for tax. Dividends from equity income funds suffer a flat rate of 10% tax at source no matter what earnings band you fall into even within Isas – but there is no further tax to pay.
Building a portfolio
Whether you choose the DIY route to investing or get help from a financial adviser, it's important to know what strategy you want to adopt.
Investors can do well to drip-feed money into their savings plan.
Tom Stevenson, investment director at Fidelity, says: "Regular saving matters for long-term investors. It helps them avoid piling in at the top of the market and bailing out at the bottom. By automating the process of investing, you can take the emotion out of it and end up with a much better outcome. Monthly savings plans are a much better way of investing into an Isa than leaving it all to the last minute and rushing into a decision."
Diversification is key and a stocks and shares Isa can, in fact, be invested in anything from equities to corporate bonds to gold or even wheat futures.
Nick Hungerford, chief executive at Nutmeg, the online investment service, says: "If you're looking to the investment landscape for higher gains, it's important to look at the full breadth of opportunities out there – stocks and shares, bonds and commodities, across all types of industry sectors and countries."
McDermott says: "If you have a long time period in which to invest, you can afford to invest in riskier assets that have the potential to produce higher returns. I'd suggest a portfolio that is 100% in equities to start with. Over time, you can adjust your portfolio. We suggest reviewing investments once or twice a year to make sure you are still on track."
Some tips from our experts:
Hannah Edwards, commercial director at BRI Asset Management, tips Aim shares that are now available to hold within the tax-free Isa wrapper. Aim, formerly called the Alternative Investment Market, is a trading platform for small firms that need to raise money from investors but cannot afford, or prefer not to go for a full stockmarket listing.
While smaller companies are notoriously volatile, they can grow faster than bigger firms – and some will soar, offering stellar returns. Edwards says: "Aim shares, already exempt from inheritance tax in most cases, provided they've been held for more than two years, will also be exempt from capital gains tax and income tax if tucked into an Isa. Plus there will be no stamp duty to pay from April."
Edwards tips the Miton UK Smaller Companies fund and GLG Undervalued Assets Trust.
Not everyone can afford to save the full Isa allowance each and every year. But putting a little something away every month is better than doing nothing.
You might not become a millionaire by saving £50 a month but every little helps. If you invested that sum every month for 25 years, and it grew at an average rate of 5% a year after charges, you would still end up with nearly £30,000. If you could double your monthly investment to £100, then that figure could rise to a much more impressive £60,000.
Many investment funds offer regular investment plans from £25 or £50 a month, without paying for advice, from fund supermarkets such as Alliance Trust, Bestinvest, Cavendish Online, Chelsea Financial Services, Fidelity and Hargreaves Lansdown.
Nutmeg helps you build an investment portfolio with £1,000 to start with and then £50 a month.
Switching cash holdings
Under Isa rules, investors can switch existing Isa savings held in cash Isas over to a stocks and shares Isa.
Over the past year, companies have reported a surge in such transfers as savers become disillusioned with ultra-low interest rates offered by banks.
At one point last year, three times as many investors transferred their cash Isas to stocks and shares Isa compared with the previous year, according to Hargreaves Lansdown. The top funds for cash Isa transfer over the past three months include the HL Multi-Manager Income & Growth Trust, Artemis Income, Marlborough Multi Cap Income and Cazenove UK Smaller Companies.
The ISA rules allow investors to transfer money from an uncompetitive savings account with one provider into one from another provider that pays a better rate of interest. The bank to which you are transferring the money must do the transfer process, as withdrawing the money from the ISA wrapper means you lose the tax-free status. You can transfer a cash ISA into a stocks and shares ISA, but not the other way around and the current tax year’s cash ISAs must be moved whole to a single provider, but previous years’ ISAs can be split between new providers.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
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.
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.
A type of derivative often lumped together with options, but slightly different. The original derivative was a future used by farmers to set the price of their produce in advance before they sowed the seeds so that after the harvest, crops would be sold at the pre-agreed price no matter what the movements of the market. So a future is a contract to buy or sell a fixed quantity of a particular commodity, currency or security (share, bond) for delivery at a fixed date in the future for a fixed price. At the end of a futures contract, the holder is obliged to pay or receive the difference between the price set in the contract and the market price on the expiry date, which can generate massive profits or vast losses.
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.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Alternative Investment Market
AIM is the London Stock Exchange’s international market for smaller companies. Since its launch in 1995, 2,200 companies have raised almost £24 billion listing on AIM. The market has a more flexible regulatory system than the main market and can offer tax advantages to investors but its constituents are a riskier investment than bigger companies listed on the main market.
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.