Plant the money tree in springtime

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Tax-efficient investing - March 2014

Life is not that easy of course but we do have the option of investing our spare cash, then watching it – hopefully – grow. The snag is that the taxman invariably wants a slice of our investment return too, much like someone charging us for the use of their land in planting our hypothetical money tree.

Some patches of land for growing money trees are cheaper than others, or put in different terms, some investment vehicles are not taxed whereas others are.

Isas, which have enjoyed massive growth in recent years, are among the most popular and accessible means of tax-efficient saving, their growth in popularity possibly due to there being no restrictions on when they can be used. Unlike pensions which only become available for use at the age of 55 – rising to 57 from 2028 – Isas can be dipped into at any time.

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They currently come in two sizes, either cash Isas in which you pay no tax on your interest; and stocks and shares Isas, in which no capital gains tax is paid, nor any further tax on any income.

Danny Cox, head of financial planning at Hargreaves Lansdown, points out that in many cases, it costs no more to hold cash and investments inside an Isa than to hold them outside so investors can receive these tax benefits for free.

All change

In the Budget earlier this month, the chancellor made some unexpected changes to Isas that will take place from July 1.

At the moment there is a limit on the amount which can be sheltered in Isas, which between April 6 until July 1 is a limit of £11,880 of which £5,940 can be in a cash Isa.

From July 1, however, the government is merging the two types of vehicle into the New Isa (Nisa) allowing transfers between the two types. It is also raising the annual limit on investments into Nisas to £15,000. This can be solely in a cash Nisa, a stocks and share Nisa, or a combination of the two.

In his Budget statement George Osborne stated: “Twenty-four million people in this country have an Isa. And yet millions of them would like to save more than the annual limits...Three-quarters of those who hit the cash Isa limit are basic rate taxpayers.

“So we will make Isas simpler by merging the cash and stocks Isas to create a single New Isa. We will make them more flexible by allowing savers to transfer all of the Isas they already have from stocks and shares into cash, or the other way around.”

Short-term solution

Mr Cox says under the current regime: “Cash Isas work very well for short-term savings of less than five years or as an emergency fund; the interest is tax-free and savers should shop around to ensure they receive a good interest rate.” However he cautions that over the long term cash Isa returns are unlikely to beat the rate of inflation, the rate at which prices rise.

Stocks and shares Isas, meanwhile, have the capacity to provide significantly higher returns for investors who are prepared to waive the capital security of cash.