IT IS surprising how many City folk – versed, as they often are, in the intricacies of structuring complex financial products – don’t know the basics of individual savings accounts (Isas).
It isn’t uncommon to need to explain to bankers that the Isa allowance can be taken every year; that it isn’t a product in itself, but a wrapper to protect your saving from taxation; and that this money remains protected from tax indefinitely.
An Isa is in essence a tax break on income earned on investments – without which basic-rate, higher-rate and additional rate taxpayers are pilfered of much of any earnings on their investments.
As long as you are a UK resident or a Crown employee (such as a diplomat or member of the armed forces, who is working overseas but paid by the government or the husband, wife or civil partner of a Crown employee) and 16 or over for a cash Isa and 18 or over for a stocks and shares Isa you qualify.
In the current tax year – which runs from 6 April 2011 to 5 April 2012 – the annual Isa allowance is £10,680 (£5,340 of which can used for a cash Isa). Although this might not sound like a fortune, a plethora of Isa millionaires are dotted across the country to prove the benefits of sustained, well-managed, diversified compounding investments. There are even strong arguments that the flexibility provided by Isas trumps the benefits of pensions (particularly employee-only contributed pensions) – for those with the discipline to leave their investments alone to fructify.
Although Isas need to be segmented from the temptations of holidays and new cars to really benefit, they cannot be ignored. Many cash Isas lie dormant, earning pitiful interest, ravaged by inflation. Equally, too many shares Isas are in expensive funds that are underperforming the index its manager is failing to track.
There are many myths to bust. Below, experts set the record straight on three.
“IT’S ALL TOO COMPLICATED”
With literally thousands of investment funds to choose from it is understandable that many would-be investors fall at the first hurdle and never get started.
I would encourage new investors to set up a monthly direct debit into their Isa rather than doing this as a lump sum. This puts the investment process onto “auto-pilot” and should avoid the worry of putting in a lump sum each year and trying to pick a “good” time to invest.
I would also advise investors to keep the portfolio simple. You can get a very low-cost, well diversified equity and bond portfolio with just three funds to start with – a UK stock market tracker, an international tracker and a fixed interest fund. If you commit to rebalancing this every now and again, by buying more of what has fallen and taking profits on funds that have gone up, you’ll be on track to building a decent portfolio.
“SWITCHING IS DIFFICULT”
At the start of every new tax year there’s a huge focus on finding the best home for your latest tax free savings allowance.
A best buy account will help maximise your returns on your current year cash Isa, but it’s even more important to keep a close eye on those Isa balances you’ve accrued in previous tax years, as the rates on these accounts may no longer be competitive.
If you want to move an old Isa account to somewhere paying a better rate, simply approach the new provider and ask them to arrange for your existing account(s) to be transferred.
Although the Office for Fair Trading has ruled that Isa transfers should take no longer than 15 working days, in most instances the switch takes place much sooner. It’s worth noting that Halifax and Nationwide Building Society will pay interest from the day your signed application is received, rather than the date the balance arrives.
“IT ISN’T WORTH IT”
The government adds to your savings in a way it would not do if your investment were outside an Isa and subject to tax. How much the government effectively adds and its worth will depend on the type of investment and what rates of tax you would have to pay if your investment was not in an Isa. The table below shows you for every £100 net return that you would receive outside an Isa how much the taxman adds to the Isa based on current tax rates.
1. The maximum would apply where the sole return was capital growth and subject to capital gains tax at 18 per cent. Some basic rate taxpayers might have to pay some capital gains tax at 28 per cent, which would increase the maximum to up to £39. No additional amount is received for any dividend payments.
2. The maximum would apply where the sole return was capital growth and subject to capital gains tax at 28 per cent. The additional amount for dividend payments would be £33.
3. The maximum would apply where the sole return was dividends and subject to income tax at 42.5 per cent on the gross dividend. The additional amount for capital growth subject to capital gains tax at 28 per cent is £39.