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| ISAs are useful
tax-saving wrappers. Using them to their best involves some
surprisingly difficult decisions. |
Health warning
We hope you are clear that an ISA is a wrapper, not an investment.You
cannot "invest in an ISA", no matter
what the advertisements say. You can only invest in X, Y or Z. Then,
you can chose to hold X,Y or Z in an ISA. Financial service providers
like to blur this distinction so that they can sell you the whole
package. And once they've got you they can rely on you not to pay
too much attention when they raise the charges, or when the in-house
funds they have put you into fail to perform.
Some ISAs charge up to 5% initial fee and 1.5% per
annum thereafter. This will kill your returns (compounding).
And don't think you will get any special management expertise. These
fees will be spent on sales commissions and marketing expenses.
Any hot investment manager (if there is such a thing) will be assigned
to high profile specialist funds. Not to general funds aimed at
the inexperienced public.
The facts
Each individual can place up to £7,200 per year in an ISA,
of which up to £3,600 may be invested in cash (a 'cash ISA')
and the balance in stocks and shares (a 'stocks and shares ISA').
Subsequently it is permissible to switch cash into a sotcks and
shares ISA, but not vice versa. This reflects the governments stance
that ISAs are for long-term investment and stocks and shares are
to be encouraged for that purpose.
All interest in a cash ISA is tax free. No income
tax or CGT is payable in a stocks and shares ISA; interest on temporary
cash balances pays tax at 20%, irrespective of the your personal
tax position.
You can take cash out of an ISA (either directly or
by selling investments) at any time, but you cannot later put it
back again. Further you cannot carry an unused ISA allowance forward
from one year to the next. It's 'use it or lose it'. This is what
makes the personal decision difficult.
Choosing an ISA
The two themes are flexibility and low cost. Your ISA could be for
life. Without flexibility you cannot adjust to meet changing circumstances,
nor do you have any defence against rising costs. ISAs that satisfy
these conditions will almost certainly be simple, not heavily promoted,
without sign-on inducements.
For a cash ISA, look for:
- good interest rate
- easy exit (or you have no recourse when your
good rate disappears)
- low account management charges
- easy switch into a stock & shares ISA
For a stocks and shares ISA, look for:
- one that
will allow you to hold a good range of investments. ISAs described
as "self-select" will do that. There are lots of them.
Account management charges
- good interest rates on cash balances. Remember
you cannot move cash out of the ISA and move it back later. So
you are stuck with cash balances from dividends accumulating in
the ISA until you have enough to make another investment.
- low dealing charges. These
may be higher than for dealing in your usual brokerage account.
- ability to move investments to a brokerage account
without sale and repurchase
- no exit fees
Our advice
It is extraordinarily difficult to give generalised
advice on ISAs. We make a number of points below.
Every one should be qualified with the words 'probably' and 'depending
on your personal circumstances', and it is for you to do the maths
that will help you make your own decision:
- The worst that can happen to you, if you
open an ISA and later want to withdraw the investment, is that
you will have wasted an annual administration fee but saved a
bit of tax.
- A low taxpayer will not get much benefit
from an ISA today. Will you still be a low taxpayer in 30 years
time?
- .....but if you are still poor in 30 years time
perhaps you will even more regret the time and money you have
wasted on ISAs?
- The tax benefits of a SIPP are more than
those of an ISA, but you lose control of your capital in a SIPP
- If you have decided not to have an ISA, why
don't you at least put £3,600 of your cash cushion into
an ISA and save 20/40% tax on the interest until such time as
you need the cash?
- On shares you save tax of 0/22.5% on dividends
and CGT of 18% - which you will only pay if you have used your
annual CGT exemption of £9,200 (2007/08). So it's better
to put cash in an ISA than shares, isn't it...........
- ....but if you put cash in an ISA you can't
get at it without losing any future tax benefits. Isn't liquidity
the whole point of cash?
- .....and the return on shares should be better
than the return on cash. If the equity risk premium is 3% then
in 30 years time you will be getting tax relief on a sum that
is two and a half times bigger than the cash equivalent.
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