Stocks and shares Isas: how they work

Published by Philip Scott on 11 March 2016.
Last updated on 11 March 2016


Notwithstanding any surprise moves by the Bank of England, March 2016 will mark the seventh anniversary of interest rates being stuck at their historic low of 0.5%.

Savers have witnessed banks and building societies slash their deposit rates to typically negligible levels. And many commentators don’t believe rates will rise significantly for several years. So plucky savers tired of enduring paltry rates of return from their cash Isa may need to up the ante and move into the stock market if they want to get their money working harder for them.

Over recent years it appears investing has become the new saving, as a greater number of people seem to be diving into the stockmarket.

Numbers from HMRC show that by the end of the 2014/15 tax year, there was more than £170 million invested in stocks and shares Isas across the country, up from some £80 million in 2008/09.

While a cash Isa is merely a tax-free savings account, a stocks and shares version gives you the opportunity to invest your money in stock markets worldwide. Investing comes with its fair share of risk, as returns will fluctuate and would-be investors need to ensure they are happy to put their money away for the long term, with the rule of thumb saying this should be at least five years. But the rewards can potentially be considerable.

Maike Currie, investment director for personal investing at Fidelity International, says: “For anyone who is unsure on whether stocks and shares is the way to go or whether they should stick their savings in cash, our calculations show that if a saver had invested £15,000 into the FTSE All Share index over the 10-year period from 31 December 2005 to 31 December 2015, they would now be left with £25,768.

“If, however, they had invested £15,000 into the average UK savings account over the same period, they would be left with £16,096. That’s a difference of nearly £10,000 – too big for anyone to ignore.”


Tax benefits

A stocks and shares Isa is simply a tax-efficient account or ‘wrapper’ for which you can choose the underlying investments. All UK residents aged 18 and over are entitled to an annual stocks and shares Isa allowance of £15,240 for the 2015/2016 tax year, but don’t have to invest the full amount.

If you are saving and/or investing and not using your annual allocation, you are just giving the taxman more of your cash than you actually need to. When you save and/or invest outside the Isa wrapper, if you are a basic-rate taxpayer you are hit with a 20% tax charge on any interest on your investments, rising to 40% for higher-rate taxpayers and to an even heftier 45%, for those in the top bracket.

Any growth on your investments is subject to capital gains tax of 18% or 28% when you sell them, although individuals have an annual capital gains tax-free allowance of £11,100 for 2015/16.

But you can invest up to £15,240 in an Isa, in the 2015/16 tax year, and all your capital gains are free from the clutches of HMRC, so use as much of the current allowance as you can.

While £11,100 a year sounds like a decent capital gains allowance, it could change in future. The only snag is that income derived from dividends – profits which companies share with their investors – are hit with a 10% tax at source that you can’t claim back through an Isa.

As in the case of cash Isas, you have until the end of the tax year, 5 April, to open an account and invest the money. If you do not take advantage of your allowance, you will lose it as it cannot be rolled into the next year.

Importantly, though, you can split as much of the allowance as you like between investments, cash, or any mixture of the two, so you do not need to take on any more risk than you are comfortable with. As is the case with cash Isas, you can opt between putting away lump sums as and when you wish into the account and/or making regular contributions.

From an investment perspective, you are perhaps better drip-feeding your money into the market on a regular basis rather than throwing in large sums, as it helps your money to ride out any market volatility.

Remember, too, that an Isa allowance is allocated per individual, so for a couple this year’s allowance is a decent £30,480. You can also invest for your children in a Junior Isa, or Jisa, where the same tax advantages apply but the limit is set at a far lower £4,080.

If you already have a cash Isa, under new rules you can now transfer your money over to a stocks and shares version, you do not need to sell up and then reinvest. To switch providers, contact the Isa provider you want to move to and fill out an Isa transfer form to move your account. If you withdraw the money without doing this, you won’t be able to reinvest that part of your allowance again.


What can I put in?

You can put a wide range of different investments into your stocks and shares Isa, including company shares and/or bonds – the latter are IOUs issued by governments and corporations looking to raise cash, which pay a fixed rate of return. For the most part, however, and certainly for novice investors, funds are a better option. These are pooled investment schemes, run by professionals who pick a broad number of investments on behalf of their investors.

Funds, also referred to as unit trusts or OEICS, come in all shapes and sizes. They can invest in, say, the UK market, while others invest globally. Some just invest in stocks; others in bonds; and there re those, sometimes dubbed multi-asset funds, which hold both, as well as other investments such as commercial property.

The advantage of investing in a fund is that your money is spread over a variety of investments, so all your eggs don’t sit in one basket.

Online platforms

While fund management groups sell Isa wrappers for their own funds, as do some banks, these tend to be more expensive and you will typically be restricted to only holding products from that manager within your Isa. The vast majority of people tend to buy an Isa via a fund platform - an online fund supermarket such as Hargreaves Lansdown, The Share Centre of Interactive Investor. These platforms allow you to pick and choose from a vast selection of investments from different providers.

Justin Modray, founder of Compare Fun Platforms, says: “Using an investment platform allows you to mix and match from a wide range of different fund managers within a single Isa. The downside is that investment platforms charge for their services but, even so, it is still likely to be cheaper overall versus buying from a manager directly.”

Platforms tend to suit DIY investors happy to make their own decisions in terms of choosing where they want to invest. The vast majority of fund platforms also provide plenty of free online guides to help you choose funds to suit your risk appetite and investment goals.

What are the costs?

You could go via an independent financial adviser but they typically tend to only deal with individuals with more than their annual Isa allowance to invest, usually around the £50,000 mark, and they will charge you either a percentage fee of the amount you want to invest, or an hourly rate.

Platforms tend to charge an annual fee, either as a percentage of your Isa value with no fund dealing fees or as a fixed amount with additional fund dealing fees. Percentage fees tend to work out cheaper for Isas below around £50,000 a year, while fixed fees start to become better value above this, depending on how often you will trade funds.

In terms of the best value platforms, Mr Modray highlights that Cavendish Online and Charles Stanley Direct, offer the lowest annual platform fee at 0.25% a year, which can be cost effective for smaller portfolios and when starting out. He adds that Interactive Investor can be good value for a fixed-fee platform, with an £80 annual fee that includes two free trades
a quarter, with additional trades charged at £10.

But these are just the platform and dealing charges for the wrapper; you will pay for the funds you invest in, too. Check the ongoing charges figure (OCF) or Total Expense Ratio (TER), to get an idea of what you will pay every year.

For actively managed funds, where a fund manager is buying and selling stocks on behalf of investors, you should not pay more than around 1% a year. For tracker funds, which echo the performance of a particular market or index, such as the FTSE 100, you should not pay more than 0.1% to 0.2%.

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