Don't pay tax on your investments
By holding your investments within a stock and shares Isa you are able to shelter your money from capital gains tax and if you are a higher rate taxpayer you can reduce the income tax you pay on dividend income.
For basic rate taxpayers this is taxed at 10% whether your money is in an Isa or not, but higher and additional rate tax payers will have to pay an extra 22.5% or 27.5% on this income if their money isn't held in an Isa.
When you buy your funds, your fund supermarket will give you the opportunity to hold your investments within this tax-efficient wrapper. In the 2014/15 tax year you can invest £15,000 in a stocks and shares Isa.
Each Isa allowance is individual – you can't have joint accounts - so that means couples can shelter double that allowance. So only individuals saving more than £15,000 a year, or couples putting away more than £30,000 in the 2014/15 tax year need to worry about tax.
For basic rate taxpayers there may not be much incentive to hold your money in an Isa, but even if you don't expect to pay capital gains tax, you never know what the future holds – you may end up with more to invest over time and your portfolio could grow faster than expected.
Without an Isa you would need to sell your holdings gradually to avoid paying the tax (the 2014/15 capital gains allowance is £11,000). In addition Isas are more convenient as you do not have to declare any income you earn from them on your tax return.
If you are saving for your retirement, and are confident that you will not need to access your money until that time, you might decide to hold your money in a self-invested personal pension or Sipp.
Unlike Isas you may have to pay tax on pension income it eventually generates (if it exceeds your personal allowance at the time) but you do get the benefit of tax relief on your contributions. This is based on your own rate of income tax and effectively means that it only costs a basic rate taxpayer £80 to invest £100, while higher rate taxpayers only pay £60.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
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.
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.
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.
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.