How to cash in on the new ISA rules
If you will be aged 50 or older during the current tax year and have been considering where to stash your spare cash, you could take early advantage of new ISA rules designed to encourage people to save more. The amount you can place in these tax-efficient accounts will increase from 6 October.
Even if you are younger, from 6 April next year you'll also be able to benefit from the higher limits.
But before you take the plunge and invest the maximum allowance, it’s wise to get your head around some ISA basics. So here’s our guide to help you pick the best account for your needs.
Q: What’s an ISA?
The government introduced ISAs in 1999 to encourage us to save by offering tax incentives. ISAs replaced personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs).
An ISA is not an investment in its own right, but a tax-efficient ‘wrapper’ that can be placed around a variety of investments, such as cash, or stocks and shares. This wrapper protects your investment from capital gains and income tax, meaning you don’t have to pay any tax on your interest or investment return.
Q: What is the current allowance?
The amount of money you can put into an ISA each year is due to increase from £7,200 to £10,200, following changes in 2009's Budget. The new annual ISA allowance includes up to £5,100 that can be saved in a cash ISA – up from the current limit of £3,600. Or you may choose to place up to the full £10,200 in the market.
People born on or before 5 April 1960 will be able to take advantage of the new limit from 6 October 2009, while everyone else will have to wait until 6 April 2010. So, the majority of savers will only be able to save up to £7,200 in an ISA, including a maximum £3,600 in cash, this tax year.
While waiting for the new rules to come into effect, a one-year savings bond could be the ideal home for your savings.
Moneywise reviews today's best savings accounts
Q: Why are the changes being introduced?
The new limit aims to appease savers who have seen interest rates being slashed since the economy nosedived. The allowance had only previously increased once since it was introduced in 1999, so another rise was long overdue.
“This change is a much-needed way for people to increase their return on savings while interest rates are low,” says Andrew Hagger, spokesperson for price comparison website moneynet.co.uk. “Showing support for elderly savers was obviously a great political PR move. However, the additional financial benefit for savers doesn’t add up to a life-changing amount.”
For example, if you invested your additional £1,500 allowance from October to April in a cash ISA paying 3%, your total return would be £22.50, according to moneynet.co.uk. However, if it was in a taxable savings account you would get £18 after basic-rate tax, so the tax benefit of an ISA only amounts to £4.50.
Q: Is the new limit here to stay?
Experts agree that the new limit is here for the long haul. “It could even increase again within the next few years if the Tories are seeking a ‘quick win’ at reasonably low cost to the Treasury,” warns Martin Bamford, managing director of independent financial adviser Informed Choice.
On ISAs’ tax-efficient status, Hagger says: “If either party decides to cancel the ISA allowances, it will be a highly contentious move because it was introduced to encourage people to save. And with pension provision looking far less certain, as many employers cut back on final salary schemes, saving has become even more important.”
Q: How should I use this extra allowance?
You have a number of choices. For instance, you could top-up any existing ISA contributions straight away if you qualify for the higher allowance this month.
However, Bamford says: “I suspect that many people will wait until just before the end of the tax year, and then use their allowance if they’re comfortable with market conditions.”
Also, you can pick between cash and stocks and shares. “With markets starting to recover and better economic prospects ahead, but interest rates remaining very low, equities will see more attention than cash from this extra allowance,” Bamford forecasts.
But David Black, head of banking at financial analyst Defaqto, says that it also depends to a large extent upon the investor’s attitude to risk. “Another factor is whether they’re likely to want access to the funds quickly,” he adds.
When you do venture into the market, remember that you don’t have to invest your entire allowance at once; in fact, regular monthly saving reduces the risk of poor market timing. This approach enables you to buy units over a period of time when the price is fluctuating – known as pound-cost averaging.
You are buying on both the highs and the lows, which helps to protect your investments from sharp swings in the market.
Q: How do I choose the right ISA?
As is the case with all savings accounts, it is essential to shop around and compare interest rates to get the best cash ISA deals. Don’t assume that your bank will offer the best product for you.
Cash ISAs are now widely available from the leading supermarkets, as well as high street banks, building societies and online banks, but they are not a single, generic product.
The range of ISA products available includes easy access, fixed-rate and notice accounts, and rates can vary significantly. As a general rule, notice and fixed-rate accounts tend to pay higher rates of interest, but read the small print before you make your final choice. Interest also tends to be higher than for a regular savings account.
Stocks and shares ISAs can be invested in a variety of investment funds, individual stocks and shares, as well as fixed-interest investments such as bonds. This type of ISA carries more risk as, ultimately, there’s no guarantee that you will get all your original investment back.
Yet the upside is you may get higher returns over longer periods of, say, five to seven years, as well as benefiting from the expertise of a fund manager, who will make investment decisions on your behalf.
To ensure you find the right product for you, speak to a financial adviser.
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Q: Are they still worthwhile?
Despite several rule changes along the way, ISAs remain a beneficial savings plan for one reason: tax-efficiency. You can set aside some cash every tax year in these accounts and keep it out of the taxman’s grasp.
Basic-rate taxpayers save the 20% tax on interest earned that would be deducted on a non-ISA account. If you’re a higher-rate taxpayer, you’ll make heftier savings, as you usually face a 40% bill.
David Black says: “Rates on cash ISAs are generally fairly low at the moment and many will question whether that makes them worthwhile compared with other savings accounts or paying off debt, but each year’s ISA allowance is on a ‘use it or lose it’ basis.”
The tax benefits on stocks and shares ISAs are not as good as when they were first launched. In earlier years, you were able to reclaim the 10% tax paid on dividends, which is the income paid to people who hold shares.
However, in April 2004, the 10% dividend tax credit was scrapped. This means, unfortunately, that basic-rate taxpayers pay exactly the same tax on dividends as they would if they held the investment outside the ISA wrapper. However, higher-rate taxpayers still make some savings, as they avoid the extra 22.5% they would otherwise pay on dividend income.
Stocks and shares ISAs are also exempt from capital gains tax, so any growth is yours to keep. And a major advantage for those sick of dealing with piles of paperwork is that you don’t have to declare your ISA on your tax return.
Q: What are the rules?
Once you’ve invested your annual limit you cannot pay more in, even if you’ve made a withdrawal. Say, for example, you’re over 50 and pay in the full £10,200 but take out £1,000 the next month, you can’t put that £1,000 back in your ISA in the same tax year. Your ISA holding may be below the limit but you’ve already used your annual allowance.
You can transfer cash ISAs from a previous tax year from one provider to another without having an impact on the current year’s allowance.
However, many of the decent rates for cash ISAs don’t accept transfers in, so if you’re shopping around for a new home for last year’s cash ISA, you will need to read the small print before comparing rates.
Until April 2008 you could not move money between cash ISAs and stocks and shares ISAs, but the rules have changed. You are now able to transfer money from a cash ISA into a stocks and shares ISA.
This will allow you to start your savings in a cash ISA, if you don’t want to risk them on the stockmarket, and then roll them over into stocks and shares ISAs when you’ve built up a larger fund and are happy to take the risk.
Unfortunately, however, this won’t work the other way round, so you can’t move your money back into cash.
Q: How easy will it be to top up my ISA?
Best buy fixed-rate ISAs have proved so attractive that many banks have been pulling these accounts from the market in recent months. So what does this mean for cash ISA savers looking for a home for their additional allowance?
“People who have to find an account for this are likely to be disappointed over the next six months,” says Martin Bamford. “We don’t expect interest rates to start going up again until next year at the earliest.”
Andrew Hagger adds: “You are only entitled to hold one cash ISA in each tax year, and some providers may not be in a position to enable customers to top up their existing accounts as they might not have the systems in place.”
So, you may face picking from the range of accounts your provider has on offer at lower rates of interest for your extra sum.
Simply picking the most competitive savings account for the time being may be the best option for you, suggests Bamford, and then you can move your money to a better account at a later date.
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.
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 financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
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.
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.
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).
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.