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Individual savings accounts (ISAs) were introduced on 6 April 1999, replacing tax-exempt special savings accounts and personal equity plans. The structure of ISAs has since been simplified so that just cash ISAs and stocks and shares ISAs are now available. In the last tax year alone over 15 million ISAs were opened, of which nearly 12 million were cash ISAs. The total amount invested was more than £53 billion. From 1 November 2011 the introduction of junior ISAs will extend availability to children.
Tax advantages
Interest, bonuses and dividends received are free of income tax, although the 10% tax credit on dividends cannot be reclaimed. Gains are free of capital gains tax, although the benefit of capital losses is lost. If cash is held within a stocks and shares ISA awaiting investment, then there is a flat rate 20% charge on any interest earned - but this is not income tax as such.
The tax advantages are obviously greater for people paying tax at the higher rates. For example, the best interest rate currently available (October 2011) for an instant access cash ISA is around 3%, although higher fixed rates are available if investment is made for a fixed period. This is an effective gross rate of 5% for a higher rate taxpayer, and 6% for an additional rate taxpayer.
Funds can be withdrawn from ISAs at any time without the loss of tax relief, although the interest rate for many cash ISAs includes a bonus that is only payable if the investment is left untouched - typically for 12 months. And normally where investment is made for a fixed period, withdrawals will result in the loss of interest.
It is not necessary to declare income and gains received from ISAs on a self-assessment tax return. ISA income does not result in the loss of age-related personal allowances for those aged 65 or over, or the personal allowance for those with income in excess of £100,000. ISA income is also not included for tax credit purposes.
Eligibility
Only individuals can open ISAs (they cannot be held jointly by spouses or civil partners, held on behalf of anybody else, or held in trust), and normally an individual must be permanently resident in the UK. If someone goes to live abroad then they can keep their existing ISAs, but cannot pay in any more money. ISAs cease to be tax-exempt from the date that an individual dies, and the tax exemption does not extend to inheritance tax - they form part of a person’s estate.
The minimum age limit for cash ISAs is 16, and for stocks and shares ISAs it is 18. However, if a parent contributes towards a cash ISA held by a child aged 16 or 17, then the income can potentially be taxed as the parent's and therefore not be tax-free.
Junior ISAs can be opened by parents for children under 18 who do not have a child trust fund - most children born between 1 September 2002 and 2 January 2011 will have a child trust fund. Anyone can contribute towards a junior ISA, including parents, family members and friends. In the case of parents, the income will always be treated as the child’s. No withdrawals are normally permitted until a child reaches 18, and at that age a junior ISA will automatically convert to a normal ISA.
Investment limits
Each tax year an individual can open one cash ISA and one stocks and shares ISA. For 2011-12 the cash ISA investment limit is £5,340 and the stocks and shares ISA limit is £10,680. The overall investment limit is £10,680. Therefore if a cash ISA is not opened the full limit of £10,680 can be invested in a stocks and shares ISA. If a cash ISA is opened then only the balance remaining of the £10,680 limit can be invested in a stocks and shares ISA. The ISA investment limits will increase each year in line with the consumer price index, so the limits for 2012-13 will probably respectively be £5,580 and £11,160.
A problem can arise where someone opens a cash ISA but does not invest the full £5,340. This is because many fixed rate ISAs do not permit the account to be topped up, while others do not allow further investment once they have been taken off the market. Surprisingly, HMRC seem to turn a blind eye to investors opening a second cash ISA in order to utilise the balance of their investment limit, provided they are not repeat offenders.
With junior ISAs the overall investment limit is £3,600, but this can be split between a cash junior ISA and a stocks and shares junior ISA as desired. The limit will remain unchanged for 2012-13. Somewhat surprisingly, there is no interaction between junior ISAs and normal ISA investment limits. Therefore, someone aged 16 or 17 can benefit from both the overall junior ISA limit of £3,600, and the normal cash ISA limit of £5,340.
The investment limits are once only - for example, if £5,340 is put into a cash ISA during 2011-12 and then £2,000 is subsequently withdrawn, it is not then possible to make any further investment during 2011-12.
The deadline for using the 2011-12 ISA allowances is 5 April 2012. If an individual opens both a cash ISA and a stocks and shares ISA then they can either be with the same provider or with different providers.
Permitted investments
The investment in a cash ISA will normally be in the form of a cash deposit with a bank or building society, although NS&I also offers a cash ISA.
Within a stocks and shares ISA it is possible to hold any shares listed on a recognised stock exchange anywhere in the world, government and corporate bonds, unit trusts, open ended investment companies (OEICS) and investment trusts, but not unquoted shares, shares listed on the alternative investment market, options or futures. However, many ISA providers only offer a limited choice of investment funds - often just the funds managed by the provider itself. To have access to the full range of qualifying investments it will probably be necessary to have a self select ISA with a stockbroker, and even then the choice may be restricted, for example, to just FTSE 350 companies.
Subject to certain conditions, shares can be transferred into an ISA from an HMRC approved employee share scheme, but it is not possible to transfer windfall shares or inherited shares since subscriptions must be in the form of cash. It is also possible to hold certain life assurance policies within a stocks and shares ISA. Cash can only be held pending future investment.
With minor exceptions, the same range of investments will be permitted in junior cash ISAs and junior stocks and shares ISAs.
Transfers
Various transfers are possible:
It is not possible to transfer a stocks and shares ISA to a cash ISA.
The same rules apply to junior ISAs. It is not possible to transfer the savings in a child trust fund to a junior ISA, although the Government is planning to consult on whether the two products should be more closely aligned.
The right choice?
There are normally no charges involved with a cash ISA, but an individual must be careful that the tax saving is sufficient compensation for the lower interest rates that are sometimes paid on ISA accounts compared to normal savings accounts. A survey in March 2011 found that the Halifax was paying gross interest of 3.35% on its one year fixed rate bond, but just 2.00% on a similar cash ISA. Even higher rate taxpayers would have been marginally better off with the non-ISA account (3.35% less 40% income tax is a net return of 2.01%). A review of some of the savings accounts currently offered by some of the major high street banks and building societies indicates that this is generally no longer the case. For example, the Nationwide is paying the same rates across its range of one and two year fixed rate accounts. Somewhat strangely, the Halifax is now paying the same rates on its two-year fixed rate accounts, but 0.5% less on its one-year fixed rate cash ISA compared to its similar non-ISA account. Generally, cash ISAs are probably the right choice for everyone except for non-taxpayers, although it pays to shop around as interest rates vary widely between providers.
It can be much more difficult in deciding whether a stocks and shares ISA is the right choice. Charges will vary according to the type of investment, and also between providers. For example, the annual management fee for a self select stocks and shares ISA with £20,000 invested can vary between nothing and £120. However, for many fund type ISAs the charges may be no higher than if the investment was made outside of any ISA. The additional charges incurred by holding investments within an ISA must be compared to the potential tax savings.
As far as income tax is concerned, there is no benefit to receiving dividends within a stocks and shares ISA for basic rate taxpayers as the tax credit cannot be reclaimed. There is no capital gains tax benefit if gains would otherwise be covered by the annual exempt amount (currently £10,600). Stocks and shares ISAs will therefore be most appropriate for higher and additional rate taxpayers who already have sufficient gains to make use of the annual exempt amount. In addition to avoiding any additional income tax liability on dividend income, they will be saving capital gains tax at the higher rate of 28%. However, a stocks and shares ISA may be appropriate for a basic rate taxpayer where they invest in interest-bearing investments such as corporate bonds, since interest received will be tax-free - saving tax at 20%.
David Harrowven is an ACCA tax examiner
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Individual savings accounts
By David Harrowven
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Individual savings accounts (ISAs) were introduced on 6 April 1999, replacing tax-exempt special savings accounts and personal equity plans. The structure of ISAs has since been simplified so that just cash ISAs and stocks and shares ISAs are now available. In the last tax year alone over 15 million ISAs were opened, of which nearly 12 million were cash ISAs. The total amount invested was more than £53 billion. From 1 November 2011 the introduction of junior ISAs will extend availability to children.
Tax advantages
Interest, bonuses and dividends received are free of income tax, although the 10% tax credit on dividends cannot be reclaimed. Gains are free of capital gains tax, although the benefit of capital losses is lost. If cash is held within a stocks and shares ISA awaiting investment, then there is a flat rate 20% charge on any interest earned - but this is not income tax as such.
The tax advantages are obviously greater for people paying tax at the higher rates. For example, the best interest rate currently available (October 2011) for an instant access cash ISA is around 3%, although higher fixed rates are available if investment is made for a fixed period. This is an effective gross rate of 5% for a higher rate taxpayer, and 6% for an additional rate taxpayer.
Funds can be withdrawn from ISAs at any time without the loss of tax relief, although the interest rate for many cash ISAs includes a bonus that is only payable if the investment is left untouched - typically for 12 months. And normally where investment is made for a fixed period, withdrawals will result in the loss of interest.
It is not necessary to declare income and gains received from ISAs on a self-assessment tax return. ISA income does not result in the loss of age-related personal allowances for those aged 65 or over, or the personal allowance for those with income in excess of £100,000. ISA income is also not included for tax credit purposes.
Eligibility
Only individuals can open ISAs (they cannot be held jointly by spouses or civil partners, held on behalf of anybody else, or held in trust), and normally an individual must be permanently resident in the UK. If someone goes to live abroad then they can keep their existing ISAs, but cannot pay in any more money. ISAs cease to be tax-exempt from the date that an individual dies, and the tax exemption does not extend to inheritance tax - they form part of a person’s estate.
The minimum age limit for cash ISAs is 16, and for stocks and shares ISAs it is 18. However, if a parent contributes towards a cash ISA held by a child aged 16 or 17, then the income can potentially be taxed as the parent's and therefore not be tax-free.
Junior ISAs can be opened by parents for children under 18 who do not have a child trust fund - most children born between 1 September 2002 and 2 January 2011 will have a child trust fund. Anyone can contribute towards a junior ISA, including parents, family members and friends. In the case of parents, the income will always be treated as the child’s. No withdrawals are normally permitted until a child reaches 18, and at that age a junior ISA will automatically convert to a normal ISA.
Investment limits
Each tax year an individual can open one cash ISA and one stocks and shares ISA. For 2011-12 the cash ISA investment limit is £5,340 and the stocks and shares ISA limit is £10,680. The overall investment limit is £10,680. Therefore if a cash ISA is not opened the full limit of £10,680 can be invested in a stocks and shares ISA. If a cash ISA is opened then only the balance remaining of the £10,680 limit can be invested in a stocks and shares ISA. The ISA investment limits will increase each year in line with the consumer price index, so the limits for 2012-13 will probably respectively be £5,580 and £11,160.
A problem can arise where someone opens a cash ISA but does not invest the full £5,340. This is because many fixed rate ISAs do not permit the account to be topped up, while others do not allow further investment once they have been taken off the market. Surprisingly, HMRC seem to turn a blind eye to investors opening a second cash ISA in order to utilise the balance of their investment limit, provided they are not repeat offenders.
With junior ISAs the overall investment limit is £3,600, but this can be split between a cash junior ISA and a stocks and shares junior ISA as desired. The limit will remain unchanged for 2012-13. Somewhat surprisingly, there is no interaction between junior ISAs and normal ISA investment limits. Therefore, someone aged 16 or 17 can benefit from both the overall junior ISA limit of £3,600, and the normal cash ISA limit of £5,340.
The investment limits are once only - for example, if £5,340 is put into a cash ISA during 2011-12 and then £2,000 is subsequently withdrawn, it is not then possible to make any further investment during 2011-12.
The deadline for using the 2011-12 ISA allowances is 5 April 2012. If an individual opens both a cash ISA and a stocks and shares ISA then they can either be with the same provider or with different providers.
Permitted investments
The investment in a cash ISA will normally be in the form of a cash deposit with a bank or building society, although NS&I also offers a cash ISA.
Within a stocks and shares ISA it is possible to hold any shares listed on a recognised stock exchange anywhere in the world, government and corporate bonds, unit trusts, open ended investment companies (OEICS) and investment trusts, but not unquoted shares, shares listed on the alternative investment market, options or futures. However, many ISA providers only offer a limited choice of investment funds - often just the funds managed by the provider itself. To have access to the full range of qualifying investments it will probably be necessary to have a self select ISA with a stockbroker, and even then the choice may be restricted, for example, to just FTSE 350 companies.
Subject to certain conditions, shares can be transferred into an ISA from an HMRC approved employee share scheme, but it is not possible to transfer windfall shares or inherited shares since subscriptions must be in the form of cash. It is also possible to hold certain life assurance policies within a stocks and shares ISA. Cash can only be held pending future investment.
With minor exceptions, the same range of investments will be permitted in junior cash ISAs and junior stocks and shares ISAs.
Transfers
Various transfers are possible:
- The money in an existing cash ISA can be transferred to a cash ISA with another provider. This may be to obtain a better rate of interest, or maybe to consolidate various old ISAs into just one account.
- The money in an existing cash ISA can be transferred to a stocks and shares ISA either with the same provider or a different one. If the cash ISA being transferred is for the current tax year, then it is treated as never having existed. For example, during 2011-12 £4,000 is put into a cash ISA, and this is then transferred to a stocks and shares ISA. The full £5,340 cash ISA limit is still available for 2011-12.
- The investments in a stocks and shares ISA can be transferred to another stocks and shares ISA with another provider. This assumes that the new provider will accept the investments that are held in the existing ISA, which will often not be the case where only a limited range of investment funds are offered.
It is not possible to transfer a stocks and shares ISA to a cash ISA.
The same rules apply to junior ISAs. It is not possible to transfer the savings in a child trust fund to a junior ISA, although the Government is planning to consult on whether the two products should be more closely aligned.
The right choice?
There are normally no charges involved with a cash ISA, but an individual must be careful that the tax saving is sufficient compensation for the lower interest rates that are sometimes paid on ISA accounts compared to normal savings accounts. A survey in March 2011 found that the Halifax was paying gross interest of 3.35% on its one year fixed rate bond, but just 2.00% on a similar cash ISA. Even higher rate taxpayers would have been marginally better off with the non-ISA account (3.35% less 40% income tax is a net return of 2.01%). A review of some of the savings accounts currently offered by some of the major high street banks and building societies indicates that this is generally no longer the case. For example, the Nationwide is paying the same rates across its range of one and two year fixed rate accounts. Somewhat strangely, the Halifax is now paying the same rates on its two-year fixed rate accounts, but 0.5% less on its one-year fixed rate cash ISA compared to its similar non-ISA account. Generally, cash ISAs are probably the right choice for everyone except for non-taxpayers, although it pays to shop around as interest rates vary widely between providers.
It can be much more difficult in deciding whether a stocks and shares ISA is the right choice. Charges will vary according to the type of investment, and also between providers. For example, the annual management fee for a self select stocks and shares ISA with £20,000 invested can vary between nothing and £120. However, for many fund type ISAs the charges may be no higher than if the investment was made outside of any ISA. The additional charges incurred by holding investments within an ISA must be compared to the potential tax savings.
As far as income tax is concerned, there is no benefit to receiving dividends within a stocks and shares ISA for basic rate taxpayers as the tax credit cannot be reclaimed. There is no capital gains tax benefit if gains would otherwise be covered by the annual exempt amount (currently £10,600). Stocks and shares ISAs will therefore be most appropriate for higher and additional rate taxpayers who already have sufficient gains to make use of the annual exempt amount. In addition to avoiding any additional income tax liability on dividend income, they will be saving capital gains tax at the higher rate of 28%. However, a stocks and shares ISA may be appropriate for a basic rate taxpayer where they invest in interest-bearing investments such as corporate bonds, since interest received will be tax-free - saving tax at 20%.
David Harrowven is an ACCA tax examiner