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By: Tim Bennett
28.02.2020
Background
If you are planning to use your ISA allowance before 5th April, here is a summary of the key features and few of the less well-known quirks. Remember – it’s “use it or lose it” so don’t delay if you want to capture the benefits for the 2019/20 tax year.
The basic deal
Unlike personal pensions, ISAs are fairly straight forward in many ways. The key thing to bear in mind is that an ISA is just a wrapper for a range of investments that offers protection from income and capital gains tax once they are inside it. The basic deal can be summarised as follows;
What you can include
Over the years, the range of eligible investments has been expanded so that now most well-known investments can be held inside an ISA wrapper. The funds list (below) can include many unit trusts and listed investment trust companies.
The tax effect
The tax rules around ISAs are reasonably simple and differ from the more complex ones that surround personal pensions. In short, every £1 placed inside the ISA wrapper becomes £1 you can invest – there is no further relief offered as there is with a personal pension. However, once inside an ISA any investments can subsequently grow free of income or capital gains tax. Furthermore, there is no tax (or any penalty) payable on withdrawals at any time
The tax effect
The best way to appreciate the potential benefit of this wrapper is via a chart. Here (below) we can see the difference between a sum invested (the green bars) and the extra tax-free growth that could be achieved at three assumed growth rates (the pink bars). The important thing is not the absolute numbers but rather the size of the pink area, albeit this is stated before charges.
Over the short-term, in particular, you should note that the value of your investments can fall as well as rise and with equity investing you may not get back the amount invested.
Flexibility
Now for some of the ISA quirks. One is the difference between a transfer and a withdrawal. Whilst you may switch ISA providers in any tax year, there is a process to follow that achieves this. Be wary of withdrawing funds from an ISA altogether as this can negate any future tax benefits unless you reinvest within the same tax year.
Other quirks
There are a few more things to look out for with adult ISAs and these are summed up below. Perhaps the most important one for older investors is that ISAs are subject to inheritance tax, unless a surviving spouse is able to take advantage of the additional permitted subscription (APS) rules which in effect protect accumulated ISA benefits and transfer them via a special one-off extra allowance in the year of death.
The case against?
Lastly, whilst ISAs are very helpful to many investors, there are a few other ways of achieving some of the tax protection that you should be aware of before opening an account.
But…
However, useful though these other allowances are, there is no guarantee that they will be maintained and for many wealthier investors they won’t be enough. Also bear in mind that whilst ISAs are an inefficient way to hold cash, most investors should not be in that asset class for long in any case, a topic I cover in other videos.
Now is a good time to…
So, if you are keen to get going with an ISA this year, what should your approach be? In a nutshell, here are some things to think about and potentially discuss.
To find out more
Please feel free to email on [email protected] or contact an Adviser if you would like to know more about this topic or how to go about setting up an ISA.
