Over the last few weeks I’ve been investigating the utilisation of tax effective saving as the end of the tax year is fast approaching. The most common form of tax effective savings is of course the ISA. ISAs and its predecessors have been chopped and changed over the last decade or so, but I think it has been simplified with its incarnation today.
ISA Overview
ISAs this year allow you to save up to £7200 a year tax free. This will increase to £10,200 in the next tax year, with individuals over 50 able to take adantage of this now. The great thing about the ISA is you can build a large despoit in years to come, where interest generated from it is tax free. However, if you withdraw money from and ISA, that is forever lost, you cannot put that money back in on top of your annual allowance that you are entitled to save.
There are two types of ISAs: Cash, and Stocks and Shares. You may open one of each type per year, and you are permitted to save half (£3600) of your tax free allocation in a cash ISA; the rest in Stocks and Shares. You don’t have to open one a year of each type, you can continue to invest in current ISAs instead.
Finally, you may transfer ISAs between providers, with is a rather lengthy process, but enables you to keep you money tax free if you unhappy with an account. You are also able to transfer a cash ISA into a stocks and shares ISA, but not the other way round.
Cash ISA
The former is just like a savings account, but interest is tax free. Providers of these ISAs offer both variable rate of return or a fixed rate of return per year. At the moment variable rates tend to offer less than half a percent in interest, with fixed rates around the 3% mark for a two year period. It is still worth investing in Cash ISAs despite modest returns, as once interest rates pick up again, you will be able to benefit from your savings you have made this year.
Whether or not it is best to go for variable or fixed rate in the current climate, I am inclined to say fixed-rate. There has been remarkable growth in the past year, however analysts are saying that FTSE 100 will peak in June, so I’m believe to stimulate growth beyond, interest rates (and hence variable rate ISAs) will not rise by too much.
Stocks and Shares ISA
In a Stocks and Shares ISA, your money is invested. There is increase risk and you may get out of it less than you put in. They make money in two ways.
Firstly, capital gains. Simply, this is the difference between the cost of when you bought the instrument, and the price you get when you sell the instrument. This can be capital gains, or capital loss. Loss can be used to offset other gains. Stocks and Shares ISAs are exempt from this calculation, which also means that if you make a loss in an ISA you cannot use it to offset capital gains in other investments.
In addition to this, you have dividends for equities and coupons for gilts and bonds. For the former this is taxed at the basic rate automatically. The only saving here is for high tax payers.
The actual packages available on the market for stocks and shares ISAs come in two broad categories, Managed and Self-Select.
In the former, you hand your money over to investment professionals who will make money for you – often charging a fixed administration fee and/or a percentage of the value of your investment. There are a wide range of these to suit your own preference on risk/reward.
The second is usually tied to a trading account and allows you to trade stocks (including international), gilts and bonds, investment and unit trusts and ETF/ETC. The noticeable missing feature is here are derivatives.
Within an ISA there is the additional rule of not being able to take a short position – so if the we enter a bear market, then to prevent you loosing money, you would have to close all your positions, effectively turning it into a 0% Cash ISA. However it would be worth keeping it here as withdrawing means you wont be able to utilise these funds tax-free again once the market changes direction.
The above paragraph isn’t entirely true. ETF/ETC or Exchange Traded Funds/Commodities respectively are a basket of securities traded as if it were one itself. However the XUKS is a fund that shorts against the FTSE100, SOIL shorts oil and there are plenty more. I have confirmed with ISA providers that this is allowed.
With all share dealing you have to pay 0.5% stamp duty for UK stocks, and take into account brokerage fee of around £10 per execution.
Beyond an ISA
For all capital gains outside an ISA you are subject to Capital Gains Tax. You do however get an Annual Exempt Amount of £10,100 a year, a bit like your personal allowance on your income when calculating income tax. This amount is missed out by a lot of people, and I think you should be looking at ways, such as trading beyond the ISA limits to make use of a tax free income. Beyond this, capital gains tax is currently at 18% which is prefiable if your paying anything over basic tax rate.
In addition, gilts and certain bonds bought and sold on the secondary markets are exempt from capital gains tax anyway.
Betting may be for some people out there, and this is also tax free. This includes financial spread betting, which I won’t go into in this article.
Another tax free opportunity comes in the form of venture capital trusts which may provide you with both capital gains and income tax relief. This is for people who are looking further into the future, with a period of at least five years.
National Saving and Investments, the government saving arm also has a number of products, however I believe the only one worth noting is the Index-linked Saving Certificate which guarantees to beat the Retail Price Index.
For those who are interested in a fully rounded knowledge there are little-known historical small tax free investment through Friendly Societies, but I don’t think they are worth consideration.