Get your ISA skates on
Time is running out if you haven’t used your allowance
Time is running out if you haven’t already discussed with us how you could take advantage of your tax-efficient 2008/09 Individual Savings Account (ISA) allowance. We have provided answers to some of the most frequently asked questions we receive from clients.
Q: What is an Individual Savings Account (ISA)?
A: ISAs are tax-efficient and flexible wrappers. They don’t have to run for a fixed term to qualify for these concessions and they benefit from tax-efficient growth. You do not have to pay any income tax or capital gains tax when you cash in your ISA. An ISA doesn’t have to be mentioned on your tax return.
Q: Who can have an ISA?
A: Anybody over the age of 18 (16 for a cash ISA) is able to save using an ISA as long as they are a UK tax resident. You can also take out an ISA even if you are not currently working. You and your partner are both able to set up an ISA as you receive separate ISA allowances. You cannot take out a joint ISA with somebody; however, you could subscribe to an ISA on behalf of someone else, for example as a gift.
Q: How much can I save in an ISA?
A: There is an overall annual maximum investment limit for ISAs, and separate limits apply to each element. ISAs allow you to save up to £7,200 during the 2008/09 tax year. For this current tax year you can save up to £3,600 in a cash ISA with one provider. The balance of the £7,200 limit (£3,600) can be invested in stocks and shares with another ISA provider.
ISA type
ISA limits for the 2008/09 tax year
Stocks and shares ISA Up to £7,200
Cash ISA Up to £3,600
Combined maximum £7,200
Q: Why should I consider using a cash ISA?
A: If you are investing for less than five years, or are a cautious investor, a cash ISA may be the most appropriate option. However, you need to ensure that the interest rate is higher than inflation, otherwise the purchasing power of your savings will reduce. In this current low interest rate environment, if you have cash sitting on deposit in a bank or building society it may be more advantageous to place some of this money into a cash ISA. It is also important to make sure that you leave yourself with an adequate emergency fund. Money on deposit with a bank or building society is normally taxed at your highest rate of income tax, but all interest is tax-free from a cash ISA.
Q: Why should I consider using a stocks and shares ISA?
A: Over the long term, equities tend to outperform cash and bonds, but they are riskier. The stocks and shares component of an ISA can offer you a wide choice of investments to choose from. These include funds such as unit trusts, OEICs or investment trusts. You could also choose to invest directly into equities, gilts or corporate bonds.
Q: What benefits do I gain by holding shares in my ISA?
A: There is no immediate tax advantage for basic rate taxpayers, but if you are a higher rate taxpayer you benefit because you avoid the extra tax payable on dividends received outside ISAs. If you are a basic rate taxpayer you can still gain a tax advantage if you invest in corporate bond funds, because the 20 per cent tax on the interest can be reclaimed. You also have no capital gains tax to pay on any increases in the value of your investments. In addition, you could benefit when you retire because the income from ISAs is not counted towards the age allowance.
Q: How are the dividends from ISA stocks and shares taxed?
A: If you’re a basic rate taxpayer inside or outside an ISA, you pay tax at 10 per cent on dividend income. This is taken as a ‘tax credit’ before you receive the dividend and cannot be refunded for ISA investments. If you’re a higher rate taxpayer, you would normally pay tax on dividend income at 32.5 per cent. In an ISA you won’t get back the 10 per cent dividend tax credit element of this, but you will save by not having to pay any additional tax.
Q: In the current volatile environment, should I keep clear of stocks and shares?
A: This will depend on your own attitude towards risk for return. However, by regular saving you can drip-feed your money into the stock market, which is a good way to help smooth out the effects of market volatility. Saving regular amounts not only avoids the risk of bad timing, but also removes the need to try and second-guess the stock market’s next move. This is called ‘pound cost averaging’, which means that when prices are high your monthly contribution may buy fewer shares or fund units, but when prices are low your investment buys more shares or fund units. This also assumes there will be a net increase in the investment value over time. The credit crunch may have led many ISA investors to give equities a wide berth, but some are now seeing this as a buying opportunity.
Q: What should I do with my old ISAs?
A: If you have a cash ISA that is now paying a poor rate of interest, or a stocks and shares ISA that has not been performing well, you could transfer your money elsewhere without any loss of tax concessions providing the transfer is arranged by the new manager. You should note that an old stocks and shares ISA cannot be transferred to a cash ISA.
The value of investments and the income from them can go down as well as up and you may not get back your original investment. Past performance is not a guide to future performance. Tax benefits may vary as a result of statutory change and their value will depend on individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent finance acts.
