Why you are going to need an Isa this year

published 5 April 2012

I know, I know, I know. This time of year all you hear about are those flaming Isas. "You must get your Isa money in now... Use it, or lose it..." and all that guff.

I'm sure you're already aware of the oft-touted reasons for this tax-efficient wrapper and how you can shield your winnings from the taxman.But today I want to show you three not so well flagged reasons why Isas are going to be more crucial as time rolls on. If you generally don't bother with an Isa, then please allow me a couple of minutes to change your mind.

What you get from an Isa

Here are the two benefits you'll hear about Isas. Put your money in an Isa and you get your income (ie, interest or dividends) paid tax free. And on top of that, you get capital gains tax free too.

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I know that these benefits sound pretty meagre given the way the markets have been working for the last decade or so...

I mean, if you're only getting 3% on your cash, then setting up an Isa to shield you from income tax on this pittance hardly seems worth it. And all you can put away is £5,340 (going up to £5,640 as of tomorrow, for next year).

And when it comes to shares, we've become too used to returns that barely seem to go anywhere. We can all get near-on £10,000 capital gains free from the taxman each year anyway. So why bother with an Isa?

Well here are my three reasons. You won't find them in the personal finance sections of the papers this is real life, it's how I see it...

You only realise when it's too late

Most of us invest in shares to make capital gains. It's the allure of capital gains that attract us.

Though it may seem like a distant memory, when stock market gains come, they tend to come all at once. And when they do it's too late to do your tax planning.

I've suffered it, and I'm sure you have too. Gains come out of the blue and they push you over the capital gains threshold. Of course you can hold-off selling your winners nobody's forcing you tomake a capital gain. But I've seen that go pear-shaped. I'm thinking specifically of the dotcom period. Loads of investors close to me held on to stocks though they probably knew the jig was up. Ultimately they didn't want to pay the taxman his dues and it clouded their judgement.

I know the stock market doesn't resemble those halcyon days but that's the point...

You get your tax planning in early nobody knows what's round the corner. But just to be sure, you get your capital tucked away in a tax-free wrapper. For just a small cost (relative to the tax-bill you could ultimately get lumbered with), you'll be ready to unleash your might on the financial world.

And you might need that tax shelter

A couple weeks ago I said I could see the FTSE doubling over the next decade. I explained how that was more to do with an inflation push, than a valuation pull.

Frankly I'm getting more and more concerned about the onset of this inflation push. Don't get me wrong, here at The Right Side we're relatively well positioned for inflation; but as with the seventies, that may not be enough not if inflation becomes a serious menace.

Sure asset values may rise (as they tend to do with inflation), but the taxman is going to want his pound of flesh too. And rising assets are an obvious first port of call. I don't want to scare you with talk of taxation during the seventies, but let's just say, you may do very well to have your reserves in a government-endorsed tax-wrapper like an Isa. Remember, when the day comes and the taxman squares up to you, it's too late to start planning tax mitigation.

You need to get your retribution in early!

Putting your money in an Isa may not be a great tax benefit today. But in tomorrow's world it may provide you with the most wonderful tax-free armoury to fight your waythrough a high-inflation, high-tax world.

And then there's the other thing...

A couple of weeks ago I had the misfortune to have to report the collapse of a spread betting company I'd advised readers to use for a bet on the break-up of the euro.

Thankfully (as with all FSA regulated institutions), it is covered by a compensation scheme that will see investors covered for up to £50,000. And I think this was a timely reminder. During these tempestuous times we really must try to keep our investments within the limits of the FSCS scheme.

So if you're currently holding more than the FSCS guaranteed limits (generally £85,000 for cash and £50,000 for investments) with any one financial institution, then it's probably a good idea to spread your investments around a bit.

And opening a new Isa with a new institution could be a great opportunity to do just that.

I know it's always a bit of hassle opening an Isa and if you open a new one every year, then that's assured administration. But if you're going to do that anyway, then it's a good excuse to change your provider each year too.

That way you should be able to spread your financial risk and help to build up a pot of money out of reach of the taxman at the same time.

I know the advantages of tax-free savings may not sound fantastic today. But I believe they're going to become more and more important.

We have a government desperate to cash in money wherever it can and we have sowed the seeds of inflation down the line. And frankly I can only see matters getting worse.

If you're not putting your money away in physical assets, then at least ferret it away in a government sponsored tax avoidance scheme. I suspect you'll do all right.

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

Important Information

Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.

Managing Editor: Frank Hemsley. The Right Side is a regulated product issued by Fleet Street Publications Ltd.

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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.

He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.

Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.