Five reasons to start a regular ISA savings plan
1.The discipline of monthly saving
Many ISA providers – both cash and equity-based – offer a regular savings option as an alternative to one-off payments into your investment. This means you can save smaller sums straight from income.
It’s straightforward and painless to set up a regular direct debit, and there is nothing to stop you adding occasional lump sum payments when you’re in the money, provided you stay within the annual ISA limit of £10,200 (in the 2010/11 tax year).
Regular savings schemes do have minimum monthly contribution requirements, but these are set at more manageable levels than the £1,000-plus lump sum minimums stipulated by most plans. Fidelity FundsNetwork’s Isa plan, for example, requires at least £50 per month, but some providers have lower limits.
"M&G allows monthly savings of £10, Invesco Perpetual £20 and Henderson £25 on its GlobalCare funds," comments Justin Modray of financial website candidmoney.com.
If you have an instant access cash ISA, then you should be able to put in as much or as little as you wish each month - just check your provider's terms and conditions.
3. Tax advantages
As with a lump sum ISA, your investments gain value without you having any further income or capital gains tax to pay (though dividend payments into equity Isas are taxed at 10 per cent at source and this cannot be reclaimed).
The ISA's tax-free status becomes really important over the very long term. For example, if you save £100 each month into an unwrapped fund for 30 years, you’ll have contributed £36,000.
But if your fund grows at an average 7% a year, it would be worth around £120,000 after 30 years. That’s £84,000 of gains, and potentially a lot of capital gains tax to pay if you encash the whole fund in a single tax year.
By saving into an ISA, you sidestep the whole issue. Indeed, you don’t even have to declare the gains on your tax return.
4. Pound cost averaging
One key attraction of regular saving into an equity fund is the effect of pound cost averaging.
When share prices are rising, your monthly contributions buy progressively fewer fund units, but importantly, you continue to buy at the bottom of the market, when share prices are dirt cheap and those same contributions buy sackloads of units.
The extra units you’ve been able to afford boost the size of your investment and set you up to capitalise on eventual recovery.
As a consequence, the average price you’ve paid per unit can be lower than the straight average of the investment price over that same period. Pound cost averaging works most effectively in volatile markets, when you’re getting regular opportunities to buy relatively cheaply.
5. No sleepless nights over timing
You no longer have to worry about trying to guess what the market is going to do next. The biggest risk for lump sum ISA investors is that they make their annual investment at the top of the market, the following week share prices plummet and they are down by 20% or 30%.
This isn’t an issue for regular savers. They’re bound to make monthly payments near the height of the market, but these are relatively small, and are balanced by additional cheap units purchased after the fall.
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.