How stocks and shares Isas work
Our money will be invested in the stockmarket and have the potential to grow faster than cash savings - assuming you choose the right investments. For example, figures from the investment group Fidelity show that £1,000 invested in the FTSE All Share in December 2009 grew by £517.55 over the five years that followed. The same amount invested in a fund tracking UK cash savings rates only grew by £7.77 over the same period.
That said, investing in the stockmarket is risky, and the value of any investment can fall as well as rise. So just because the word 'savings' is included in the name of a stocks and shares individual savings account (Isa), don't be lulled into a false sense of security. These are not savings accounts, they are investments and should only be entered into after careful consideration.
And remember, the golden rule of investing is never invest what you can't afford to lose. Wealth warning aside, a stocks and shares Isa makes a great addition to a diversified financial plan and is a great place to begin your investment journey. Here's a closer look at how it works.
What is a stocks and shares Isa?
It's a tax-efficient wrapper you can put around investments such as shares, bonds, funds or investment trusts. Any gains you make on the investments you hold within the Isa become shielded from capital gains tax.
If you earn income from any of those investments, things are 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 holding their investments 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 were 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 as interest is paid on a cash Isa.
Stocks and shares Isas are also sometimes referred to as self-select Isas because they allow the investor to pick and choose what to put their money into. First-time investors can choose to invest in a 'model portfolio' put together by their Isa provider to help them get started before they're ready to pick each and every investment that Isa investing allows. For example, Hargreaves Lansdown's version is called the Master Portfolio range.
What charges will I pay?
Charges on stocks and shares Isas depend on your choice of underlying investment and the way in which you invest your money. Depending on how you buy your fund, you may face an initial fee levied by the fund management group itself (though this is more often discounted by a fund platform), as well as an annual fee charged by the manager.
These fees usually include a manager's own dealing fees and Stamp Duty charges. On top of that, you may have to fork out for an annual fee charged by the fund platform that you buy and hold your Isa with.
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 will pay the dealing charges and Stamp Duty on shares yourself, as well as an annual plan fee.
At Hargreaves Lansdown, stocks and shares Isas can be opened with a regular investment of £25 or lump sum of £100 or more. If you invest in funds, a tiered annual charge applies with a maximum annual fee of 0.45% of the amount invested. If you're not sure what to invest in right away, you can hold your money in cash until you've made your choice(s).
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?
Stocks and shares Isas can be bought direct from a fund management group but most investors use an independent financial adviser, a stockbroker or fund platform. Some banks offer them too.
Which is right for you depends on your level of investment knowledge, whether you're prepared to monitor the fund yourself and what type of investments you want to hold.
If you're comfortable making the investment decisions yourself, you may choose to open a stocks and shares Isa through a fund platform (also known as a fund supermarket), such as Hargreaves Lansdown or Interactive Investor, for the widest choice of investments. Even a first-time Isa investor may want to choose this route as it's unlikely to be worth paying for advice unless you have a large sum to invest outside your annual allowance.
How cash and stocks amnd shares Isas stack up
|CASH ISAS||STOCKS AND SHARES ISAS|
|Ideal for shorter-term savings||Good for longer-term investing and saving|
|Good if you don't want any investment risk||Ideal to take advantage of the potential growth of the stockmarket, albeit with more risk|
|Isa allowance for 2014/15 is £15,000||Isa allowance for 2014/15 is £15,000|
|There are no investment choices - you recieve interest on your savings at a fixed or variable rate||You can choose from a wide range of investments inclusing equities, funds, bonds, and ETPs|
|Low interest rates will affect the returns of your savings||The value of your investments can fall as well as rise depending on performance|
|Variable interest accounts normally mean instant access to your money. With fixed-term accounts, you could lose interest if you withdraw cash early||You can withdraw your money at any time|
How much can I put in an Isa?
Every tax year, you are entitled to a new Isa allowance. For 2014/15, this started at £11,880 but increased to £15,000 on 1 July 2014 with the introduction of the New Isa (Nisa). From 6 April 2015, it will increase to £15,240.
Like cash Isas, you have until the end of the tax year, 5 April, to open an account and pay your money in. However, you don't have to invest the full sum held in a stocks and shares Isa by that date – you can place this in a holding account and drip-feed (make smaller regular payments) it into the market.
You can also now split your £15,000 annual allowance between a stocks and shares and cash Isa in any combination you wish. Under the old system, only around half of the allowance could be invested.
Remember that once you've invested your annual limit, you cannot pay more in, even if you have made a withdrawal. For example, say you pay in the full £15,000 but take out £1,000 the next month, you can't put that £1,000 back in your Isa in the same tax year – as even though your Isa holding may be below the limit, you've already used your annual allowance and will have to wait until the next tax year to open another stocks and shares Isa.
Can I transfer one stocks and shares Isa to another?
Yes, but you must stick to the rules that limit you to opening only one stocks and shares Isa and one cash Isa in any tax year. You cannot open one stocks and shares Isa, change your mind and then open another with a different provider. But you can transfer money from previous year's Isas, or even from the current tax year's Isa, into another existing one.
You can also now transfer money from a cash Isa into a stocks and shares Isa. Previously, money was only allowed to move in the opposite direction.
The simplest way to transfer money between all types of Isas is to ask your new provider to do it for you. You'll need to complete an application form to open the new Isa, as well as a transfer request form.
The new provider will then contact your existing Isa manager and arrange for the funds to be transferred to your new one. It can also arrange for your old account to be closed.
What should I use my Isa for?
Like any investment, you should analyse your appetite for risk and return and work out how long you want to invest for and make a call on what you invest in and for how long but people generally invest in a stocks and shares Isa in order to generate a better return.
You can invest in most types of investment including shares listed on recognised global stock exchanges, UK and European gilts, corporate bonds, investment trusts and funds. This makes them ideal for longer-term savings goals, such as boosting your retirement income.
What should I do if the value of my stocks and shares Isa falls?
If you're not happy with performance, you can switch from one investment to another within the Isa wrapper. However, if you just want to hold funds and buy an Isa direct from a fund manager, you may find you have access to a limited choice of investments if you do want to switch. It's better to buy from a discount broker or fund supermarket if you want a wide choice of investments, and this may also be lower cost.
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.
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.
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.
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.
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).
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.
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.