How do ISAs work?
Individual Savings Accounts (or ISAs for short) were introduced by the Government to get Britain back into the savings habit. It’s sometimes hard to believe that it has worked – CURRENTLY we seem more interested in spending what we earn and then taking out credit to spend some more.But smart investors snapped them up. That’s because any savings you place within the ISA ‘wrapper’ as it’s called, are treated differently to regular savings and investments … when it comes to tax. You can put £7000 into ISAs in any one tax year (this goes up to £7200 in April 2008).
There are two types of ISA at present, mini and maxi. A maxi ISA can have all £7000 in stocks and shares, or up to £3000 in cash and the remainder in stocks and shares. You can only buy one maxi ISA in a year.
You can have TWO mini ISAs in a year, with up to £4000 in stocks and shares in one, and up to £3000 in cash in the other.
If the distinction between mini and maxi sounds a little artificial and pointless, well the Chancellor thinks so too. From April 08 there will be just a shares ISA OR a cash ISA, up to a total of £7200 and with a maximum £3600 to go in the cash ISA.
ISAs are NOT the great deal they used to be, as Gordon Brown and Alisdair Darling have progressively chipped away at the tax benefits. Nonetheless, interest on cash ISAs is paid without deduction of income tax. This is good for basic rate taxpayers, who hang onto 22% of their interest, and much better for higher rate taxpayers, who hang on to 40%.
But don’t simply be seduced by the tax breaks. Banks and building societies started brutally cutting interest rates on cash ISAs in early 2008. You may find that, even with the tax relief, the real interest rate you are getting is lower than with a regular savings account. Search carefully for the best deal.
It’s Share ISAs that have been the Chancellor’s real target though. You used to be able to claim back the 10 per cent tax credit on dividends, but not any more.
It means non tax payers and basic rate payers ar e no better off (as far as dividends go at least) than if they bought their shares outside an ISA. Higher rate taxpayers ARE better off, as outside the ISA they would have to pay additional tax. Inside they don’t.
But where ISAs really score is that the gains in investments held therein are exempt from capital gains tax. That means that, if you’re taking the long view, and trying to grow your pot for retirement, ISAs are an un-missable freebie from the government.
You can’t arrange your own ISA, you have to go through an ISA manager – usually a bank, a fund group or a stockbroker, and increasingly now a fund supermarket.
You can, however, select your own shares to go within the ISA wrapper. That’s if you feel sufficiently confident to make your own share picks. Remember that though you MAY pick shares as well as the experts, it’s a time consuming business, requires research and charges can mount up.
However, check out funds supermarkets and discount brokers, through which you can buy funds at below regular rates. As ever … watch out for the charges the ISA managers and fund managers levy. They can make a big difference to the amount that actually goes forward to be invested for you.
