Your IndustryMar 5 2015

Isas compared to alternative wrappers

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The obvious draw to use the Isa allowance available each year is that funds are sheltered from tax. This investors do not pay tax on the savings as they accrue, a benefit which, if savings are left largely untouched, grows with the portfolio.

Sheridan Admans, investment research manager at The Share Centre, says another major tax upside of Isas there is no capital gains tax to pay on any growth you achieve, a key advantage over standard investment accounts.

Investors will also only pay 10 per cent tax on any dividends they receive on investments in an Isa, Mr Admans says, compared with 32.5 per cent if they are a higher rate taxpayer, or 42.5 per cent if they are an additional rate taxpayer investing in a standard investment account.

Unlike with pensions, for example, investors are free to withdraw capital or income at will - subject to restrictions put in place by the lender, which will offer higher rates on accounts with more limited access - and Isas are therefore more suitable for short and medium-term planning.

Mr Admans adds Isas give access to a diverse range of investments, including now many assets which qualify for other reliefs such as business investment relief that can be used to mitigate IHT.

In terms of the downside, although the amount that can be saved in this vehicle was raised quite dramatically last year, Mr Admans says savers and investors are limited to what they can save annually.

Again comparing these accounts to pensions, the allowance allowance for Isas next year of £15,240 is far below the £40,000 allowance for the tax breaks on pension saving.

Moreover, for all the tax breaks when in an Isa there is no initial tax-saving - that is to say for most earners they will already have paid income tax on the money, meaning £2,000 invested means your pot would start at exactly this amount.

As tax relief on pensions is deferred, the contribution is ‘grossed up’ to refund the income tax paid, meaning a basic rate taxpayer would only need to contribute £1,600 to contribute the same £2,000 into their pot.

Rates

With the interest rate outlook seemingly bleak, Anna Bowes, director of Savingschampion.co.uk, adds savers are currently asking whether using their Isa allowance on a Cash Isa is worthwhile.

She points out questions about the worth of a cash Isa are increasing, especially when there are high interest rate current accounts that pay better interest, even after basic rate and higher rate tax has been deducted.

For reference, even the best five-year fixed rate on the market as at the end of February was paying 2.25 per cent, and even that withdrew interest for 180 days on any withdrawals. For one-year fixed rates, the top rate was around 1.65 per cent.

Ms Bowes says even despite the currently low rates, it can be worth continuing to use allowance to benefit from compunding over the longer term.

“The problem is that if you don’t use your Isa allowance within each tax year, you lose it forever. And while this may not seem to be a great loss right now, it would mean a reduced lump sum available to earn tax-free interest in the future.

“Savers shouldn’t forget that they could have amassed a hefty lump sum sheltered in a tax free environment so far.

“If someone had invested the maximum amount into cash Isas since their introduction on 6th April 1999 and simply earned the equivalent of the Bank of England base rate, they could now have over £80,000 sheltered from tax.”

In addition, Ms Bowes points out if they had invested the maximum each year into the precursor to the Isa, the Tessa, or Tax Exempt Special Savings Account, from 1 January 1991 and then kept the money in a tax free account – their original stake of £9,000 invested over the 1st five years could be worth more than £13,000.

Even with rates as low as they are, Ms Bowes says this could mean almost an extra £500 in tax free interest a year, for a basic rate tax payer, when compared to a taxable account. When rates do become competitive once again, Ms Bowes says this would become even more valuable.

She says: ““Even non-taxpayers should consider a Cash Isa as over time, the amount they build up in this tax-free wrapper could become considerable, yet, under current legislation, they will never need to pay tax on it, even if their tax circumstances change.”