ISAs – individual savings accounts – are a kind of ‘wrapper’ that shields your money from the taxman, so it grows free of income or capital gains tax. You can put up to £15,240 a year (for both the 2015 and the 2016 tax years) into a cash ISA (a tax-free savings account) or a stock-market ISA that holds investment funds, trusts or shares.
Since 1 December 2015 it has also been possible for would-be first-time buyers to put up to £200 a month into a Help to Buy ISA. The government adds a 25% bonus, up to a maximum of £3,000 on your £12,000 savings. Help to Buy ISAs count as a type of cash ISA, so if you are paying into one you cannot also contribute to the other in the same year (though you can pay into a stocks and shares ISA).
April 2016 also sees the launch of the Innovative Finance (IF) ISA, enabling peer-to-peer (P2P) savers to shelter the interest they earn from the taxman. Isa investors can divide their allowance as
they wish between IF, cash and shares.
Over the years the tax protection provided by ISAs can make a huge difference to their value, particularly if you’re a higher rate (40%) taxpayer and are investing in the stock market.
For example, if you had built up £100,000 of investments in a stocks and shares ISA growing at 7% a year (which included 3% income), as a higher rate taxpayer you could save more than £10,000 of tax over 10 years.
It’s not difficult to set up an ISA – but are you really making the most of your taxsheltered money? To be sure you’re getting the maximum benefit, read our 10 ISA tips.
1 CASH ISAS: SHOULD YOU BOTHER?
First port of call for anyone (after clearing debts, usually) should be cash holdings to cover shortor medium-term requirements and unforeseen emergencies.
Cash ISAs work in this context, and are also useful if you are unable to commit your money for the minimum five years or so needed for market investments, or if you cannot stomach any thought of losing money. You can put up to £15,240 this tax year into a cash ISA , and the same in the 2016/17 tax year – but be aware that rates have been falling and they currently pay barely more than inflation, so don’t expect to get rich this way.
First-time buyers will probably favour a Help to Buy ISA in preference to an ordinary cash ISA, but remember you cannot open both in the same year.
2 DIVERSIFY YOUR INTERESTS
A £15,240 ISA holding individual shares in a few companies is a pretty risky proposition, because if one business hits the skids, it will impact on your portfolio in a big way. For most smaller investors willing to accept the additional risk involved with the stock market and able to commit their money for at least five years (ideally longer), collective investments– funds and investment trusts– are a much safer bet, as they provide instant diversification.
Diversify further by spreading your investment across different geographical regions, and different assets such as bonds and property as well as shares. You may be able to do this through a single ‘multi-asset’ fund; or put several funds together; or use one of the ready-made portfolios typically comprising five to seven funds, available from many brokers.
Look, for example, at the Money Observer Model Portfolios available on Interactive Investor’s website: http://www.iii.co.uk/ investing/model-portfolios.
3 CHOOSE YOUR CHARGES CAREFULLY
Over the long term, it’s astonishing how much high charges can eat into your total returns. For example a £10,000 investment growing at 6% for 30 years would be worth almost £53,000 in a fund with a 0.3% annual charge, but only £41,000 in an identical fund charging 1.2%, according to passive fund provider Vanguard.
Passive funds, which hold all the shares in a stock market index (the FTSE 100 for instance) and simply follow it up and down, cost less than actively managed funds that involve a fund manager using research and expertise to select shares.
So look at fund charges and be sure that if you’re paying the extra for actively managed funds, your managers are adding real value by consistently delivering better returns than a comparable market index.
Look carefully also at the fees levied by the broker or platform that you’re investing through. Some charge a flat fee that may be pricey if you only have a small holding, while others work on a percentage basis that can become much more expensive as your investment grows. And you also need to consider the cost of actually buying and selling, so it’s not simple.
The Lang Cat’s chatty guide to finding the right platform is a useful read: http://langcatfinancial. co.uk/flipbooksd2c/index.html.
4 CONSIDER REGULAR SAVING
There’s much to be said for a regular monthly savings scheme for your ISA. Not only is it more manageable if you don’t have a meaty lump sum to hand, but it’s a less risky option in volatile markets.
By drip-feeding money in each month, you do away with the difficult task of trying to ‘time’ your investment, so you don’t run the risk of investing a large chunk just before a market fall. Instead, you reduce the impact of market ups and downs, because your money buys more units when the market’s cheap and fewer when it’s expensive, which can mean you end up with more shares for the same amount of money invested.
5 MIX AND MATCH WITH YOUR PENSION
“For most people the best approach to long-term investing is to use a combination of pensions and ISAs, and in fact they complement each other very nicely”, says Patrick Connolly of Chase de Vere.
Both offer tax-free growth while your money is invested – but pensions provide the best tax relief, with a generous upfront tax boost to the value of your initial investment, while withdrawals from ISAs are completely taxfree and you can access your money whenever you want.
Additionally, when you die, pensions can now be passed on to your loved ones without punitive tax charges, or even completely tax-free in some cases. ISAs, in contrast, count as part of yourestate, so it makes sense, if you have both options available, to draw income from your ISA first.
6 DON’T WAIT UNTIL YEAR END
Simply by investing earlier in the tax year each year, rather than waiting until the last-minute rush, you can make a big difference to final gains. That’s partly because of the extra time your money
is invested, and partly because the end of tax-year scramble tends to push prices up.
Fidelity did some research which found that £10,000 invested in January 2000 would have grown to over £35,000 after 15 years; the same sum invested just three months later was worth only £25,000.
7 REVIEW AND REBALANCE
To ensure that you don’t end up taking too much risk, or too little, you should look to rebalance regularly. This involves selling some of those investments that have performed well and now
dominate your portfolio, and reinvesting the cash into those that have performed poorly and shrunk in proportion. Otherwise, over time you might find you have a portfolio with an uncomfortably
large chunk of, say, smaller company or biotech funds that could easily lose value as dramatically as they’ve gained it.
Connolly advises: “The best approach for investors is to review and rebalance their portfolio on a regular basis, say every six months, or once a year in January. If you do it any more often then the charges involved in making changes could outweigh any benefits.”
8 SHELTER EXISTING INVESTMENTS FROM FUTURE TAX
Investors used to be able to ‘bed and breakfast’ an investment by selling it and then buying it back the following day to rebase its value and avoid building up capital gains tax. That’s no longer allowed, but you can ‘bed and ISA’ existing holdings, as Danny Cox of Hargreaves Lansdown explains.
“‘Bed and ISA’ is where a fund or shares are sold to the value of £11,100 – the capital gains tax exemption – then re-purchased within an ISA, so that future growth and income will be free of tax,” he says. “The sale creates a capital gain, but the profit is lower than the CGT exemption so there is no tax to pay. In April 2016, taking advantage of both tax years of ISA allowance, a couple could shelter £60, 960 of existing shares or funds into their ISAs (£15,240 x 2 for 2015/16 and the same for 2016/17), providing their gains did not exceed their combined CGT allowance limit.”
9 USE A JUNIOR ISA TO AVOID THE PARENTAL SETTLEMENT RULE
If you give money to your children and invest it on their behalf, you will pay tax on any investment income over the first £100 a year. However, if you set up or contribute to a Junior ISA (or use an existing Child Trust Fund), you can invest up to £4,080 for them this tax year, and the same amount next tax year, with no tax issues.
10 EARNING £100,000 PLUS? PROTECT YOUR PERSONAL ALLOWANCE
Not only do you pay no income tax on income from your ISA, but in addition that income does not count towards the personal allowance ‘means test’. Under this test, those with taxable income of £100,000 or more have their personal allowance of £10,000 reduced by £1 for every £2 of income they earn over £100,000; the personal allowance has completely disappeared by the time their
income reaches £120,000.
“This is an effective tax rate of 60%,” says Cox. That’s because an extra £12,000 of tax is payable on the additional £20,000 of income. However, he adds: “ISA income does not count towards this test, so you can use your ISA investments to boost your total income without jeopardising your personal allowance.”
