As we reach the end of another tax year, your post and email inbox are probably overflowing with advertisements from banks and brokers trying to persuade you to take out an individual savings account (Isa) with them. And that’s before we’ve even had time to get our breath back over the radical change that chancellor George Osborne just pushed through in this year’s Budget – a massive increase in the annual Isa allowance.
Given this annual onslaught, the number of people taking out an Isa for their investments is still surprisingly low. HM Revenue & Customs data show that 11.6 million cash Isa accounts were opened in 2012-2013, but just 2.9 million stocks and shares Isas. In monetary terms, about £41bn was paid into cash Isas and around £16.5bn into stocks and shares Isas, despite the higher contribution limit for the latter.
This gap is partly because there are simply fewer investors than savers. But considering the benefits that Isas offer, you might expect them to be the first choice for all investment accounts, with investors only turning to taxable accounts when they’ve exhausted their Isa allowance for the year. Since most investors are aware of Isas, it’s hard to see why that doesn’t happen. One possible explanation may be that it’s the fault of the brokers.
Most providers have historically charged significantly higher fees for an Isa than for a general dealing account. Many still do. While Isas do carry a slightly higher administrative burden, the difference in charges is often excessive. Investors may recognise this, conclude the higher charges make Isas a rip-off and decide to stick to cheaper accounts. This is certainly something that brokers could address, but it’s not the whole story. There are a number of Isas with no or very low fixed charges, especially for stocks. It’s entirely possible to have an Isa that’s as cost-effective as an unwrapped account for most investments.
So the more likely reason is that many investors don’t consider Isas relevant to them. Basic rate taxpayers pay no income tax on dividends, while the annual capital gains tax (CGT) allowance means that few expect to end up paying CGT. Hence the tax breaks may not seem worthwhile.
However, it still makes sense to consider an Isa rather than an unwrapped account even if you are in this situation. That’s because your tax circumstances can and almost certainly will change over the course of your lifetime – so you might be subject to higher-rate tax or have a large potential CGT liability in the future. Putting your investments inside an Isa doesn’t just shelter them from tax now – it also protects them from future tax liabilities for as long as they stay there.
Obviously, there is always the risk that a future government could change the Isa rules to make them less attractive, but that’s impossible to forecast – and it seems unlikely to happen in the very near future at least, given the coalition’s huge vote of confidence in Isas in the Budget. And the fact that you can freely withdraw your money from an Isa makes taking advantage of the breaks they currently offer a bit less of a gamble than hoping personal pensions will still work the same way in 20 years time.
So if you’re one of the many investors who don’t yet use an Isa, we hope we can persuade you to reconsider.
The basics of Isas
An individual savings account (Isa) is a type of account that shields the savings or investments you hold in it from most taxes. Up until the recent Budget, there were two types of Isa – a cash Isa, which is essentially a tax-free savings account, and a stocks and shares Isa, which can hold shares, bonds, funds and other investments. You can open one of each type in each tax year (which runs from 6 April to 5 April every year), and there is an annual limit on how much you can contribute. For the tax year ending 5 April 2014, the limit for a cash Isa is £5,760 and the limit for a stocks and shares Isa is £11,520 minus anything you pay into a cash Isa.
But this is changing from July this year. From then, you’ll be able to put up to £15,000 in an Isa, and you won’t have to differentiate between cash and investments – you’ll be able to fill the lot with cash if you so desire (though interest rates remain very unattractive just now).
Isas that you opened in past tax years stay open and you can continue to manage the money you put into them. Previous Isas can be freely transferred from one provider to another. As for the benefits – you pay no income tax on interest in a cash Isa. Stock dividends, bond interest and capital gains are all tax-free in a stocks and shares Isa, although interest on cash is taxed. There’s no tax liability on taking your money out of the Isa and you can do this at any time (subject to any notice period that applies to your cash Isas).
However – and this is important to bear in mind – once money is withdrawn from an Isa, it can’t be paid back in. So if you want to maximise your tax-efficient savings, you should try to use Isas for your long-term savings and investments, and avoid unnecessary withdrawals if you can.
• Cash Isas: Get a better rate on your savings
• Funds Isas: How to pick the best platform for you
• Stocks & shares Isas: It pays to compare brokers
• Now you can pop Aim shares into your Isa too
• Adventurous investing: Spice up your Isa with exotic investments
• Sipps: Take control of your pension