GUIDE TO ISAs 2014/15
From 1 July 2014, following reforms to the ISA system announced in the March 2014 Budget , the ISA allowance will be raised to £15,000 and you will be allowed to save your entire “New ISA” (NISA) allowance in cash or stocks and shares – or any combination of the two. Furthermore, you will be able to transfer your NISA between providers as many times as you like.
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.
With the New ISA (NISA), the amount you can put in each year is £15,000
WHAT SHOULD I LOOK FOR IN A NISA?
Cash within ISAs are simply cash accounts that sit within an ISA wrapper and therefore have 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 ISAs to hold cash, investors should check to ensure the rates on offer are competitive.
However, a high rate is not the only reason for selecting an ISA as the highest rate today might not prove to be the best rate over the longer term.
There may be ISA providers offering rates that are slightly lower but consistently competitive over the long term and these might suit those who do not want to keep shifting between providers. Furthermore, some providers tie money up for a period of time so that, although these accounts may pay higher rates, savers will pay for those rates by waiting for as long as 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.
A RANGE OF INVESTMENTS TO CHOOSE FROM
Self-Select ISA’s allow you to choose your own investments and will 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 exchange traded funds (ETF’s). The choice will ultimately depend on your reasons for investing and your tolerance for risk.
If you are seeking 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.
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 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 areas, which could be anything from large UK companies right through to Japanese bonds, To make the choice easier for you, most unit trusts and Oeic funds are sorted into sectors by the investment management Association (www.investmentfunds.org.uk) so you can compare funds with similar goals.
If you want a lower-volatility fund or if you have a relatively short timeframe it may be best to pick a collective fund that offers a lower exposure to equities. A fund in the ‘Mixed Investment 0-35% Share’ 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 is a good place to start, If you wish to be even more adventurous, there are equity fund sectors for every region in the world and, if you are seeking to generate an income, it is worth considering an investment in the bond or equity income sectors.
However, it should be noted that even traditionally low volatile investments such as corporate Bonds & Gilts are likely to suffer capital losses when interest rates start to rise. They would form 65% - 100% of the above example.
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 upfront 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 will be cheaper than, say, a Japanese Smaller Companies fund, where a fund manager selects the stocks, often using their and their company’s own in-depth research, and may have a team of investment professionals to support them.
Some tax considerations
Your tax position could also 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 ISA’s are well known for being ‘tax-efficient’, 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. On a normal bank account, basic rate taxpayers currently pay tax of 20p. As such, you receive more on your money from this type of account than you would receive outside an ISA.
Similar to cash, the interest on corporate bonds is also tax-free. However, unlike cash ISAs, the capital value 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 a 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. Under normal circumstances, basic rate taxpayers currently face a 10% tax on dividend income. This 10% tax payment is not refundable within an ISA, regardless of the tax position of the investor. You could argue, therefore, that a Stocks and Shares ISA offers little additional benefit to a normal basic rate taxpayer here – although there are still considerable advantages for a higher-rate taxpayer, who does not have to pay any additional income tax on dividend receipts.
However, based on their historical performance, equities have offered greater long-term growth potential than any other asset class and this is particularly true for areas such as emerging markets, which carry a corresponding level of additional risk. For this type of investment, the benefit of the ISA wrapper is primarily derived from the fact that investors will pay no capital gains tax.
Equities should always be considered a long-term investment as there is a possibility you may not receive back your original investment – particularly in the first few years. Before making any investment decision, you should weigh up the tax advantages against the potential risks and likely returns, If you are in doubt about any aspect, do seek professional advice.
Use it or lose it
One thing is not up for debate – you only receive one ISA allowance every tax year. You cannot carry your allowance over to the next tax year and therefore, if you do not do something about it, you will lose it.
While your annual allowance can be used at any time during the tax year, the deadline of 5 April helps to concentrate the mind and there is generally an increase in ISA investments at that time of year.
However, you do not have to wait. You can use your allowance at any time – and many would suggest the earlier the better, particularly with Cash ISAs, as the earlier you open a Cash ISA, the more interest you will earn.
For Stocks and Shares ISAs, some people still attempt to ‘time’ an investment in and out of the market although few have proved themselves adept at this type of market prediction. An alternative approach is to ‘drip-feed’ your allowance on a monthly basis, so you invest at different prices as markets fluctuate. Ultimately, this approach can help to smooth the return on your investment.
Nevertheless, regardless of how or where you decide to invest your money, you must do so before the 5th of April. At the end of the tax year, your ISA allowance is gone. So make sure you do not miss out and start your research now and/or speak to your financial adviser now.
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David Finan, Managing Director