Maximise your returns with investment Isas
Interest rates remain at rock-bottom levels, and many people are choosing to look beyond cash in an attempt to get bigger returns.
With cash Isas returning low levels of interest, stocks and shares Isas are an increasingly popular way of using your yearly tax-free allowance. By the end of the 2015/16 tax year, there was £249 billion invested in non-cash accounts, representing 48% of the total Isa market.
First launched in 1999, the stocks and shares Isa has since been joined by a range of other Isa accounts in recent times. Which Isa you choose depends on if you are saving for a home, interested in peer-to-peer lending or just looking for a better return on your cash.
Risk and reward
Stocks and shares Isas offer the prospect of higher returns than cash, although there is a greater level of risk. This kind of investment is suited to medium- and long-term investors rather than those seeking an instant return on their money.
The good news is that all the profits made in your stocks and shares Isa are tax free. Non-Isa investments are liable to an 18% tax for basic-rate payers and 28% if you’re in the higher- or additional-rate tax band, once you pass the £11,100 capital gains tax allowance.
Tax benefits for stocks and shares Isa account holders are as follows.
- Investments that pay interest (for example, government and corporate bonds), or rental income (such as some property funds) provide 100% tax-free income if held within a stocks and shares Isa and therefore offer tax benefits for everyone.
- All individuals are eligible for a £5,000 tax-free dividend allowance. Dividends received on shares within an Isa will remain tax-free and won’t impact your dividend allowance.
- Also, any profit you make when selling investments in your stocks and shares Isa is free of capital gains tax.
Rob Morgan, pensions and investments analyst at Charles Stanley, says: “The appeal of cash Isas is fading as low interest rates are hurting savers. What is more, the personal savings allowance introduced from April 2016 means that many people no longer pay tax on their savings interest in bank and building society accounts.
“With ordinary savings accounts providing similar rates in many cases, and banks now paying interest gross (untaxed) rather than net (with basic-rate tax taken off), many people are questioning the point of saving into a cash Isa and are instead looking to transfer to a stocks and shares Isa in search of superior long-term returns, albeit with higher risks attached.”
If you already have a pot of savings in a cash Isa, then it is possible to move this over to a stocks and shares product – you just need to ask the new provider for a transfer form. Don’t withdraw the cash from the Isa wrapper yourself as you’ll lose the tax advantages. But it is always a good idea to hold some cash in an easily accessible account, so consider how you want to invest and plan accordingly.
Patrick Connolly, financial planner at Chase de Vere, says: “As a starting point, you need to decide what you want to achieve, how long you are planning to invest and how much risk you are prepared to take. This will help you decide the most appropriate investments for you.
“Before investing, you should make sure that you have paid off any expensive debt and have enough money in cash to cater for any short-term emergencies or requirements.
“First time investors should usually avoid higher risk or more specialist investments, unless they fully understand the risks and are prepared to take a long-term perspective, say 10 years or more.”
Cost of investment
Investing can be a daunting task at the best of times. The FTSE 100 index of the biggest companies listed on the London Stock Exchange may have reached record highs this year, but the UK’s exit from the European Union and the long-term impact of President Trump present challenges.
To counter any short-term fluctuations, you can choose to drip-feed money into your chosen investments at regular intervals. This means you’re not risking all of your cash at one moment in time and your risk is spread over a longer period.
Mr Morgan says: “The stock market has performed very well recently, and that may put some people who are worried about buying in at the peak of the market off.
“However, the prevailing level of the market should never really put you off investing – so long as you make investing a habit and commit for the longer term, the peaks and troughs have a tendency to pale into insignificance over time.”
There is a wide range of choice when it comes to stocks and shares Isas. You can hold individual company shares, bonds or funds. Funds are holdings, which are run by professionals who pool together a number of investments. Your portfolio can cover everything from individual firms to full sectors and this allows the risk to be spread over multiple asset classes.
It is also important to remember the costs associated with this kind of investment and any ongoing dealing charges. An independent financial adviser will tend to deal with people who are investing larger sums of £50,000 or more so smaller investors must typically fend for themselves.
Most investors tend to use platforms – examples include Charles Stanley Direct, Hargreaves Lansdown or Interactive Investor (Moneywise’s parent company). These charge either a yearly fee –usually a percentage of your Isa’s value – or a fixed amount which is charged each time you make a trade.
“When buying funds through an Isa on a low-cost platform, the charges (fund annual charge and annual platform fee) are usually percentage rather than fixed ones so starting to invest with a small amount is perfectly valid,” says Mr Morgan. “A lump sum of £1,000 is one way to start – or you could commit to investing regularly from £50 per month.”
Don’t forget the other kinds of Isa
A range of new Isa accounts has been launched in recent years to cater for specific segments of the market.
The Help to Buy Isa gives aspiring homeowners assistance when buying their first home and pays a bonus once a purchase is completed.
Rates on offer are much higher than the equivalent cash Isa – the current top paying account generally available to all is from Barclays at a rate of 2.27% - but there are some restrictions. You can only pay in £200 a month, plus an extra £1,000 when you open the account. This means the total maximum saved is £3,400 in the first year and £2,400 in each subsequent year.
A bonus of 25% is paid when the account owner buys a house. The maximum bonus awarded through the scheme is £3,000 and is paid upon completion, which means it can be used for the mortgage deposit, but not for the exchange deposit and any costs incurred prior to completion.
This is only available to people who have never owned a home before, although couples may hold separate Isas and thus both can benefit from a government bonus.
Meanwhile, peer-to-peer (P2P) investments can now be held in a tax-free Isa for the first time after the launch of the Innovative Finance Isa – sometimes known as an Ifisa – in April 2016. This offers higher returns but is much riskier than other kinds of investment. The range of providers is relatively small at present with Crowdstacker and Crowd2Fund some of the bigger names in the market.
While peer-to-peer investors have seen strong returns, so far there are doubts about the long-term sustainability of the market. Mr Connolly believes this is a much riskier option than investing in stocks and shares.
“Accounts that offer higher returns typically come with more risk and, as the peer-to-peer market continues to grow and develop, we are likely to see new entrants entering the fray,” he says.
“While more competition should be positive news for consumers, with it comes increased risks that all providers might not be of suitable quality.
“You can invest up to £20,000 in Innovative Finance Isas in the 2017/18 tax year. While peer-to-peer lending is now regulated by the Financial Conduct Authority, it still isn’t covered by the Financial Services Compensation Scheme, so if a borrower or provider defaults those who invest could be left out of pocket.”
Lifetime Isas will launch in April 2017 and are an option for people saving for a first home or for their retirement. The Junior Isa is also an option for younger savers.
Types of Isa
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.