THIS IS OUR GUIDE TO INDIVIDUAL SAVINGS ACCOUNTS AND HOW TO MAKE THE MOST OF YOUR ANNUAL TAX YEAR ALLOWANCE. IF YOU WOULD LIKE TO DISCUSS ANY OF THE INFORMATION PROVIDED IN MORE DETAIL, PLEASE DO GET IN TOUCH.
WHAT IS AN ISA?
‘ISA’ stands for Individual Savings Account, a tax-efficient wrapper offered under Government legislation as a way of encouraging you to save. An ISA sits over your choice of a number of different investments to shelter them from further tax on any income or capital gains earned.
There are two types of ISA available – the Cash ISA and the Stocks and Shares ISA – and the maximum allowance for the 2019/20 tax year is £20,000 per person. The introduction of the so-called ‘New ISA’ (NISA) on 1 July 2014 saw substantial reforms to the system, with investors enjoying greater flexibility and choice. Under these updated rules, investors can allocate their entire £20,000 allowance across cash, stocks and shares, or any combination of the two. Moreover, investors can transfer their ISAs between providers as often as they like (subject to their providers’ rules).
WHAT SHOULD I LOOK FOR IN A CASH ISA?
Cash ISAs are simply cash accounts that sit within an ISA wrapper and therefore offer certain tax advantages. As with a normal bank account, the underlying account will pay a certain level of interest. Therefore, when shopping around for the best Cash ISAs, investors should check to ensure the rates on offer are competitive.
However, a high rate is not the only reason for selecting a Cash ISA. The highest rate today might not prove to be the best rate over the longer term. There may be Cash ISA providers offering rates that are slightly lower but consistently competitive over the long term. These might suit investors who do not want to keep shifting between providers. Furthermore, some providers tie up money for a period of time so that, although these accounts may pay higher rates, savers will pay for those rates by waiting up to 90 days to be able to make a withdrawal.
In essence, even these seemingly simple products need some research. Make sure you make the right choice before you commit yourself and your money.
LOOKING BEYOND CASH
UNDER REFORMED ISA RULES INTRODUCED IN JULY 2014, INVESTORS CAN ALLOCATE THEIR ENTIRE ALLOWANCE OF £20,000 ACROSS CASH, STOCKS AND SHARES, OR ANY COMBINATION OF THE TWO. IF YOU ARE LOOKING BEYOND A CASH ISA, YOU HAVE A RANGE OF INVESTMENTS FROM WHICH TO CHOOSE, AND A NUMBER OF OTHER CONSIDERATIONS TO BEAR IN MIND.
SELF-SELECT ISAs
Self-select ISAs allow you to choose your own investments. They generally offer a choice of individual shares, individual bonds or collective investment schemes such as open-ended investment companies (OEICs), unit trusts, investment trusts or exchangetraded funds (ETFs). Your choice will ultimately depend on your reasons for investing and your tolerance for risk.
If you seek capital growth, and are comfortable with the possibility of losing some or all of your capital, investing in single shares is a high-risk approach that can pay off. However, collective investments are often a more appropriate choice, particularly if your ISA investment constitutes a significant proportion of your overall savings.
COLLECTIVE INVESTMENTS
By investing in a collective investment, you are accessing not one or two but many different companies or holdings. Known as ‘diversification’, this approach is designed so that poor performance from one holding should not have a significant effect on the overall performance of your entire portfolio.
Collective schemes offer access to a whole range of different investments. Some will offer a ‘one-stop-shop’ investment into a number of different asset classes, such as equities, bonds and property. Others will focus on just one area, which could be anything from large UK companies to Japanese bonds. To make the choice easier for you, most unit trust and OEIC funds are sorted into sectors by the Investment Association (www.theinvestmentassociation. org) so you can compare funds with similar goals. The Association of Investment Companies (www.theaic.co.uk) does the same with investment trusts.
If you want a lower-volatility fund or if you have a relatively short time-frame, it may be best to pick a collective fund that offers a lower exposure to equities. A fund in the ‘Mixed Investment 0-35% Shares’ sector, for example, might be appropriate. Alternatively, if you are looking to maximise long-term growth and are prepared for 100% exposure to equities, the UK All Companies sector could be a good place to start. If you wish to be even more adventurous, there are equity fund sectors for every region in the world. If you want to generate an income, it is worth considering an investment in the bond or equity income sectors.
| UK Funds | Overseas Funds |
| UK All Companies | Global |
| UK Equity Income | Global Bonds |
| UK Smaller Companies | Asia Pacific ex. Japan |
| £ Corporate Bond | Asia Pacific inc. Japan |
| £ Strategic Bond | China/ Greater China |
| £ High Yield | Global Emerging Markets |
| UK Gilts | Global Emerging Markets Bond |
| UK Index-Linked Gilts | Global Equity Income |
| Europe ex. UK | |
| Europe inc. UK | |
| European Smaller Companies | |
| Japan | |
| Japan Smaller Companies | |
| North America | |
| North America Smaller Companies |
| Mixed Investment | Other |
| Mixed Inv. 0-35% Shares | Money Market |
| Mixed Inv. 20-60% Shares | Personal Pensions |
| Mixed Inv. 40-85% Shares | Property |
| Flexible Investment | Protected |
| UK Equity & Bond Income | Short-Term Money Market |
| Specialist | |
| Targeted Absolute Return | |
| Technology & Telecoms | |
| Volatility Managed |
Source: Investment Association, March 2019
CHARGES
When making your choice, you should also be aware of the associated charges. There may be a charge for the ISA wrapper (though this is increasingly rare), but there will be up-front and ongoing charges for the underlying investments. These fees will vary according to the complexity of the product and the company that manages it.
As such, a straightforward ETF or other index-tracking fund that mirrors the performance of an index such as the FTSE 100 Index will be cheaper than, say, a Japanese Smaller Companies fund where a fund manager selects the stocks, often using their own and their company’s in-depth research, and may have a team of investment professionals to support them.
SOME TAX CONSIDERATIONS
Your tax position could affect your investment choice but such a consideration is likely to require specific professional guidance. If you are interested in discussing your tax position further, please contact us. In the meantime, here is a summary of some of the broader issues to bear in mind.
While ISAs are well known for being ‘taxefficient’, your choice of investments can make a big difference to the level of benefit that is generated. All the income and growth you receive from your ISA is tax-free in your hand, but the treatment of each asset class is different while it remains invested – and this can be confusing.
Cash ISAs, for instance, are entirely free of income tax. Therefore, if you earn £1 in interest, you receive the whole lot. In comparison, basic-rate savers can receive up to £1,000 in savings income tax-free through their Personal Savings Allowance, while higher-rate taxpayers can receive up to £500. Any excess will be charged at the marginal rate of tax. Additional-rate taxpayers will not receive a Personal Savings Allowance and will have to pay tax on their savings interest at their marginal rate. Therefore, a Cash ISA might prove attractive to higher- or additional-rate taxpayers.
Unlike Cash ISAs, the capital value of corporate bonds can fluctuate, and there is therefore the possibility of a tax-free capital gain as well as tax-free income. Of course, this also means there is the chance of a capital loss if markets move against the investment – and there is also a risk to your income if a company defaults. As a result, corporate bonds generally pay a higher level of income than cash deposits as a way of compensating investors for taking on this additional risk.
The tax benefits on shares are a little different. Until a few years ago, basic-rate taxpayers faced a notional 10% tax on dividend income. However, from 6 April 2016, the 10% tax credit on dividends was abolished in favour of a tax-free Dividend Allowance which currently stands at £2,000. This allowance, however, does not include dividends earned via an ISA, which remain fully tax-free. ISA investors also pay no tax on any capital gains.
Based on their historical performance, equities offer greater long-term growth potential than any other asset class; nevertheless, equities should always be considered a long-term investment as there is a possibility you may not recoup your original investment, particularly in the first few years. Before making any investment decision, you should weigh up all the pros and cons and, if you are in doubt about any aspect, do seek professional advice.