An Individual Savings Account or ‘ISA‘ has been heralded as the ‘cornerstone of your savings future’. In short, an ISA offers huge tax benefits for savings and should be a part of every UK resident’s saving plan. UK residents of the right age (16 for cash ISAs and 18 for investment ISAs) are entitled to invest a given amount of money each year tax free. Allowances are not transferable to others, nor can they be rolled over to the next year, which undeniably highlights the power of regular savings.
Whilst cash ISAs are common in most households, a lot of mystery remains around the topic of investment ISAs. With interest rates almost at an all-time low, perhaps now is the right time to consider joining the dark side of stocks/shares ISA investors and sharing the bigger returns. Although I might be stating the obvious to some, it is seriously important that you remember that with increased reward, comes increased risk – the greater prize is not guaranteed.
Investment ISAs explained
ISAs were put in place by the Government to encourage saving due to their high(er) interest rates and tax efficient benefits. In addition to the option to invest cash, ISAs can also contain stocks and funds. Perhaps the easiest way to think of an investment ISA is not as an investment in itself, but more of a protective wrapper for your savings. As long as your savings are within this wrapper they are sheltered from some or all of the tax that would usually be due.
A stocks and shares, or investment ISA, enables you to invest your savings through a range of opportunities including investments registered with the London Stock Exchange, as well as corporate and government bonds; amongst others. It offers the flexibility for you to make the all important decisions on where your money is invested. As some of you will know after reading my recent post on income from investing, Mrs Scot and I have been investing all our income from this blog using ISA wrappers. We have already seen an average return of around 15% (largely due to one very good pick that I made) in the last 6 months – it would take us a decade sitting in a bank account to accumulate equivalent returns!
As I already mentioned, there is a limit on the amount of money you can deposit into an ISA in each tax year. For the current tax year a total of £11,280 can be invested through an investment ISA. This can be split across a an investment and a Cash ISA (with the total allowed in a cash ISA being £5,640). Alternatively you can invest the entire amount into your investment ISA. That said, ensure that you maximise your partners allowance if you have one – you can’t combine your limits, but it definitely makes sense to open a second account if you reach your own limit. Your limits are reset each year (they should rise annually) and your interest / gains are compounded.
As long as you keep the investments within your account you are not required to pay any Income Tax or Capital Gains Tax on the growth of your investments within the ISA.
To put this simply, basic rate tax payers would usually pay 20% income tax on any profit made on their investments, whereas higher rate tax payers would normally pay income tax at a rate of 40% or 50%. For higher rate tax payers, the amount of tax you will need to pay on dividend income within your investment ISA is also reduced. It is an absolute no-brainer to open an ISA – if you are investing in UK based equities, stocks etc. then your investments are protected from tax within this wrapper. If you have savings in a bank account – ensure that you are maximising your annual ISA limits.
UK residents over the age of 18 are able to open an investment ISA. Residents over 16 can open a Cash ISA. Junior ISAs also exist and I believe there is a slight loophole that 16-18 year-olds are eligible to invest in both a Junior and Adult ISA! To be fair, if a 16-18 year old is maxing out their ISA limits at that age… they are doing pretty well!
You are free to transfer any savings you have accrued during the current tax year from your cash ISA to your investment. You will however, have to transfer the entire amount contributed. You can also transfer any funds you have accrued in your cash ISA from previous tax years to your investment without affecting your £11,280 limit.
Deciding if an Investment ISA is right for you
Opting for an investment ISA does offer the potential for higher returns than a cash ISA, but it is designed more as a long term investment. If you are saving for something in the short term such as a new car, a holiday or even a deposit for a house and need access to your funds; a cash ISA is usually a better option. Regardless of which ISA you choose, it definitely makes sense to have one! As we are approaching the end of the tax year for 2013/2013, NOW is the time to invest and take advantage of any unused allowances!
Do you have an investment ISA? How has it performed over the last year?!