The Stocks & Shares ISA: Tax-free Investments

Posted on March 14, 2020

We encounter a great many financial misconceptions day to day: one of the more common ones is that an ISA is only a product.

Whilst this is correct in one sense (ISAs are indeed provided via a marketplace), we always advise people that it is far better to consider an ISA as an annual allowance or entitlement. An individual’s ISA allowance is basically a tax-free shelter for cash (and, if you wish, investments in other types of assets): one that is renewed yearly.

Depending on the exact ISA account (or accounts) you hold, different rules will apply. For example, you could use some or all of your ISA allowance to shelter your cash savings (or part of them) from tax.

However, recent governments have been keen to get people investing in assets such as stocks and shares, so they have also made it possible to use your ISA allowance to shelter a share portfolio, or perhaps some collective investment funds.

People often ask themselves ‘Should I buy an ISA?’ but, to our mind, a far more pertinent question would be ‘Should I be saving in a bank account or investing in the stock market?’

We meet many people who have not had this question put to them, and who really should have. In fact, in our experience it is not uncommon to meet someone who doesn’t realise that their ISA is in fact a a basket of FTSE shares via a tracker fund, sold to them by the nice man in the bank!

If you are prepared to commit your resources for a minimum of five years then it is possible that a Stocks & Shares ISA could be for you.

Investments have the potential to beat inflation

The average UK inflation rate in 2019 was 1.8% (in 2018 it was 2.3%; in 2017 it was 2.6%). If your savings are in cash then – unless they accrue interest at a rate that beats inflation – they are losing a little of their real value every year. This is the main reason people invest: they hope to beat inflation and see their savings grow in more ways than one.

If you can accept that there is no guarantee that you will end up with more money than you started with, then you might consider becoming an investor yourself.

ISA Investments can be tax efficient…

At time of writing, if a person holds an investment portfolio via a Stocks & Shares ISA, both income from those investments and any ‘capital gains’ (an increase in the monetary value of the holdings) are ring-fenced and not subject to tax – no matter what their other income is.

For investments not protected by the ISA wrapper there is a £12,000 Capital Gains tax-free allowance. Beyond that, basic-rate taxpayers will be liable for 10%, and higher / additional rate taxpayers for 20% (2019/20 rates).

Do bear in mind that this ‘ring-fencing’ works both ways. So, if you have other investments that increase in value whilst your ISA-wrapped investments fall, you cannot offset your non-ISA gains with your ISA losses.

When it comes to any income from your investments, those not sheltered by an ISA are taxed at (in the year 2019/20) 7.5% for basic rate payers, 32.5% for higher rate payers and 38.1% for additional rate payers.

… even if you change the portfolio structure…

It is the nature of investing that different types of assets will become more or less desirable as time passes. This is not just because all markets are subject to change but because your personal needs might change.

Earlier in your life you might want to take more risk with your investments because you have more time for swings in the value of your portfolio to even out; once you retire you might want to switch to holdings with a lower risk profile (so that your month to month portfolio valuation is likely to be more consistent), or to those that generate more income.

Revising the structure of a portfolio held via an ISA will not incur any tax liabilities; nor will funding further investments within your Stocks & Shares ISA from your Cash ISA; nor will converting investments back to currency and moving that across to your Cash ISA.

… but always get professional advice particular to YOU

Of course, the taxation situation outline above might not always be correct. Furthermore, it’s important to get professional advice on your entire and specific financial situation to weigh the usefulness of ISA tax advantages to you, as part of any other arrangements you have or are considering.

Stocks & Shares ISA investment portfolios can be diversified

Whilst there is no ‘magic bullet’ for investment, it is widely accepted that holding a wide range of different investments (a practice commonly referred to as ‘diversification’ and covered here [*]) provides the best protection against individual assets not generating income, or being worth less rather than more.

The UK government allows a very wide range of investments via a Stocks & Shares ISA: however it is very important to check which equities can be purchased via the ISA account you have in mind. Look out for ISA providers who seek to ‘tie’ you to certain funds and deny you access to the whole market, and avoid these types of accounts.

Do you have any debts?

If you’ve decided that you’re ready to invest, there is one more thing to check: non-mortgage debt. The most common examples are credit cards and retailer debt cards. If you have debts of this nature to settle then we’d recommend that you pay them off first. The interest on debts like these is almost certain to be more than any returns on your investments, at least to begin with.

Sizing up ISA accounts and ISA funds

If you are making provision for the longer term and you are comfortable with the idea of investing as opposed to saving, then here are some more questions you should be asking yourself:

Would you like to select the individual shareholdings yourself?

Or would you prefer to use collective funds (effectively outsourcing these decisions)?

If you’re using a fund or funds, then what are the initial charges?

These can range from 0% to 5.5% on the money you invest. If you are paying initial charges, what are you receiving in return? If it’s not advice when you need it, or active fund management, then you could be paying a meaningless and non-quantifiable ‘admin fee’.

What are the annual management charges (AMCs)?

Better yet, find out the Total Expense Ratios (TERs) of the funds selected and check for all charges. A fee whilst switching is common, and look out also for annual or quarterly fixed costs.

For ISAs offered by a bank / building society, check that you have access to the entire market. Be wary of ISAs from a single fund group.

As mentioned above, the whole point of investing is to access as diverse a range of investments as possible. An ISA via a platform or wrap is certain to provide access to funds from many different providers – and that is what you want.

How flexible is the ISA account?

If you later need to take some funds out, what is the minimum amount that must be left in to keep your account open?

What sort of access do you have?

These days there is rarely, if ever, an excuse to not provide the ability to  view and make changes to your investments online.

INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.

THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED.

STOCKS & SHARES ISA INVESTMENTS DO NOT INCLUDE THE SAME SECURITY OF CAPITAL THAT IS AFFORDED WITH A CASH ISA.

No guarantee can be given that the information provided is accurate in the present or the future. It is not intended to constitute either a statement of applicable law or financial advice, and responsibility cannot be accepted for any subsequent loss following activity or inactivity by any individual or organisation. Indeed, such information should NOT be acted upon without first receiving appropriate and specific professional advice.