An ISA is an individual savings account. It provides you with an account for saving or investing money. If you have an ISA, or are able to set one up, they’re an excellent vehicle for investing in stocks, due to the many tax benefits you can take advantage of.
Your ISA is a separate account from your normal day-to-day bank account, and is subject to different rules about fees and taxes. In the 2017-2018 tax year, you can invest up to £20,000 in your ISA.
You can invest in a wide—but not entirely limitless—range of stocks and shares from the UK and from international markets. In addition, you can invest in funds, bonds, and gilts, depending on your preferences and the institution that holds your ISA. Note that some providers allow you to choose what you want to invest in, while others offer programmes that make your investment decisions for you. It’s up to you which you choose.
The stocks and shares ISA is not tax-exempt, but it is tax-efficient, meaning that while you still pay some taxes, you pay less in taxes than you would if the funds were held in a normal bank account. For instance, you pay no capital gains tax on any interest or profit you make on money invested from your ISA. In addition, there are several other benefits an ISA-holder may be able to take advantage of.
Reduced taxes on dividend income
If your investment portfolio includes shares, or an investment in a collective entity such as a mutual fund or unit trust, it’s likely that you’ll receive regular dividend payments.
If the investments are made outside of an ISA, the first £5,000 in dividend earnings isn’t taxed, and dividends are taxed at a rate of 7.5% after the first £5,000 in dividend earnings. (In 2018 the dividend allowance drops to £2,000.) For investments held within an ISA, dividends aren’t taxed at all. If you’re earning a substantial sum in dividends each year, moving those investments to an ISA can potentially reduce your taxable income by a good amount, and increase the amount you have available for reinvesting.
This is particularly important if you pay a high tax rate or an additional rate, as you’re looking at paying 32.5% or 38.1% on dividend earnings above £5,000 if they’re earned outside of an ISA.
Capital gains
Investments held within your ISA don’t incur any capital gains tax, even if you sell those shares. Outside of the ISA, of course, you must pay capital gains tax on any profits you earn from the sale of shares. Every individual does have an annual allowance of capital gains income, which is currently around £11,000 per person. So, again, if your capital gains for the year are over that sum, you’ll likely benefit from investing within an ISA.
Interest
Like income from dividends and capital gains, there is a lower threshold that is tax-exempt for income from interest—£1000 for basic rate tax payers, and £500 for higher rate tax payers. However, all interest earned in an ISA is tax free. So if you’re investing in interest-bearing gilts or bonds, for instance, you’ll be avoiding paying tax on any earnings over the allowance.
Whether or not an ISA is worthwhile really depends on how much money your investments are earning. If your dividends and capital gains are well within the threshold limits, you don’t necessarily need to worry about using an ISA, unless you have interest-bearing investments over the allowance. However, as your earnings rise above these limits it’s worthwhile considering it. And if you’re paying a higher tax rate, or an additional rate, investing within an ISA is absolutely worthwhile.
