Why 2010 is the year of the ISA
The UK may have finally stuck its nose out of recession, but the wider economy still looks shaky. And don't even mention politics and taxation, which are fraught with uncertainty and hazards.
However, the case for using your ISA allowance has never looked more certain.
In terms of stocks and shares ISAs, there are myriad reasons: interest rates on cash savings continue to look lacklustre; you can shelter your investments from capital gains tax (CGT) and income tax; and certain asset classes such as property are finally looking more healthy.
For cash ISAs, despite a stubborn base rate stuck at 0.5%, we all need some cash savings and it makes sense to plonk it in a tax-free environment. But there has been a bit of grey area around savings accounts versus cash ISAs recently.
For the first time since their launch in 1999, the top variable ISA rate is lower than that on a standard variable savings account, according to Moneyfacts.co.uk.
If you're a higher-rate taxpayer using your full cash ISA allowance, the tax perks should outweigh a slightly lower interest rate. But basic-rate taxpayers will need to tread carefully.
Peter Day, partner at Killik & Co, explains: "ISAs offer investors a great tax-free savings vehicle. However, some cash ISA providers take advantage of the situation and do not offer particularly attractive interest rates within an ISA."
Michelle Slade, spokesperson for Moneyfacts.co.uk, believes the tide is turning though, and as we approach the ISA season ISA rates are rising while other savings rates are being cut.
Since the start of the year new or revised products have been launched by, among others, Alliance & Leicester, Birmingham Midshires, Chelsea, Leeds, The Post Office and Santander.
Rise in fixed-rate ISAs
"Providers still want to tie savers' money in, resulting in the number of fixed-rate ISAs on offer more than doubling in the last year from 39 to 84," Slade adds.
Precisely because there is uncertainty over what will happen to taxes in both the Budget and after the election makes ISAs a vital part of everyone's finances.
Yes, there is also a question mark over what will happen to ISAs in the future, as some experts believe allowances will be frozen, slimmed down, or worse, scrapped, with others predicting they will be beefed up to incentivise saving.
But with a new 50% income tax band arriving in a few months' time, and a risk of CGT increasing from 18%, they still offer a crucial shelter.
Graeme Clark, head of private clients at Courtiers, believes the ISA allowance is safe. "The ISA limit has been increased twice in 10 years and not in line with inflationary increases. The government acknowledges that we are not saving enough and need to pay off some debt.
I would therefore be amazed if the ISA allowance was scrapped and would perhaps expect some modest rises in future years,' he comments.
Record levels of debt
Conrad Simmons, senior investment adviser at Charles Stanley, adds: "With government debt at record levels, there is a strong possibility that the income tax and CGT regime may become less favourable going forward. Against this backdrop, ISAs look attractive."
ISAs are also an increasingly important vehicle for later in life. Higher-rate tax relief on pensions will become less generous next year, making ISAs (which benefit from 40% higher-rate tax relief and, after April, 50% for those earning more than £150,000) look more appealing.
Furthermore, there are no restrictions around tax-free cash.
Older people also continue to enjoy another tax break from their ISAs: income from ISAs built up over the years does not reduce the extra personal allowance the over 65s receive.
While it's true higher-rate taxpayers enjoy more tax relief on their ISAs, basic-rate taxpayers shouldn't neglect them. As Simmons points out, lower-rate taxpayers may move into a higher band in the future.
If you've already got an ISA and are maxing out your allowance, the question then becomes how to make it work extra hard in the unpredictable economic climate.
Fees on stocks and shares ISAs is one issue, as is investment flexibility. If you want more investment choice or an ISA with lower charges, for example with a cheap self-select ISA such as the one offered by Interactive Investor, then do consider changing your provider.
"ISAs are transferrable, meaning that the tax-efficient environment is not lost should an investor decide to switch provider," says Clark.
"Sums built up within cash ISAs can also be transferred to other cash ISAs should preferable rates be available from other providers, or alternatively to a stocks and shares ISA should investors decide to increase the level of risk with their capital.
Amounts transferred into an ISA from another ISA provider do not impact on subscription limits in the year of transfer."
If you're a higher-rate taxpayer then it's worth checking that your income tax-generating investments, which attract up to 40% tax, sit within your ISA wrapper, and your CGT-generating investments (18% tax) sit outside.
Dennis Hall, financial planner at Yellowtail Financial Planning, notes: "Many people don't maximise the tax efficiency of their ISA because they don't use the share ISA component properly."
He recommends putting bonds, rather than shares, into a stocks and shares ISA to gain a bigger saving.
ISAs at a glance
- They are very tax- efficient, as savers and investors don't pay income tax or capital gains tax on their ISA holdings.
- They are a flexible way to build up capital for use in later life, or as an emergency or rainy day fund for now.
- There are very few restrictions on which investments are allowed in a stocks and shares ISA and there is also a wealth of cash ISAs to choose from.
- Some stocks and shares ISAs charge an administration fee. There may be hefty penalties or time delays to switch your stocks and shares ISA provider too.
- They are not completely tax-free. If you hold shares in your ISA, you still have to pay the 10% dividend tax.
- You are only allowed to contribute a certain amount of money into your ISA each year. The maximum subscription into a stocks and shares ISA is £10,200 for those over 50, and £7,200 for everyone else. The full £10,200 will be available to all after 6 April. Half of this amount may be invested in a cash ISA. It's a "use it or lose it" allowance, as you are not allowed to roll over unused allowance into the next tax year.
This article was originally published in Money Observer - Moneywise's sister publication - in March 2010
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.
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.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
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.