Stocks and shares ISAs explained
The typical interest rate on a cash ISA is currently about 1.2% - that’s less than the rate of inflation. So it’s perhaps not surprising that many people are thinking of putting money into a stocks and shares ISA.
Many investors are also keen to kick-start their stocks and shares ISA at the start of the new tax year on April 6.
But the ISA rules are changing from July 1. The annual tax-free allowance will go up from £11,880 to £15,000. Plus, there will be greater flexibility on investments and transfers. The new tax year starts on April 6, so the July date is a bit odd. The reason for the delay is to give ISA companies time to adjust.
But what happens to ISAs between April and July?
Basically, the rules stay the same until July 1 when ISAs become New ISAs (NISAs). So, at the moment, you can invest up to £11,880 in a stocks and shares ISA. If you want to put money into a cash ISA (up to the present maximum £5,940), you can put the balance (up to £11,880) into a stocks and shares ISA between April and July.
Any money you pay into a stocks and shares ISA between April 6 and July 1 will count towards your annual £15,000 allowance for 2014-15. So, after July 1, you will be able to top up if you wish by paying into your existing account, or by switching to a different stocks and shares New ISA. Alternatively, you could open a cash NISA.
Let’s say you put the full annual allowance of £11,880 into a stocks and shares before July. When the rules change on July 1, you could add a further £3,120 (£15,000 - £11,880) to your stocks and shares account. Or you could open a cash NISA and deposit up to £3,120.
If you had instead contributed £1,000 to a cash ISA and £5000 to a stocks and shares ISA in the weeks leading up to July, you could add to either account on July 1, as long as you did not exceed the overall limit of £15,000. So, you could put an additional £9,000 into your cash NISA, or £4,500 into each account to bring you to the £15,000 limit. It’s entirely up to you how you divide the allowance.
Range of assets
A stocks and shares ISA offers the potential for higher returns than a cash deposit and you can invest in a broad range of assets including shares, bonds, commercial property and commodities. But stocks and shares ISAs are riskier than cash plans. If the stock market crashes or the property market implodes, you could lose all your money, including your original stake.
Some ISAs are riskier than others: an investment in emerging markets is likely to be more volatile than government gilts. You should therefore pick a scheme that reflects your appetite for risk.
And don’t forget that a stocks and shares ISA is a long-term investment of, ideally, at least five years. This period of time should hopefully enable you to ride out the ups and downs of the market.
Self select ISAs
Most people opt for an ISA run by an experienced manager, but others prefer to take control of their investments with a self-select ISA. It’s worth bearing in mind, however, that self-select ISAs are really only suitable for experienced investors with a full awareness of and stomach for the risks involved.
The big advantage of a stocks and shares ISA is, of course, the shelter from capital gains tax (CGT). You would normally pay CGT on any profits above £10,900 a year when you sell, but assets in an ISA are free from CGT.
The tax situation is a little more complicated if the shares in your ISA pays dividends, as 10% tax is automatically deducted from any dividends – ‘at source’, as the saying goes – whether the shares themselves are held inside or outside an ISA. Investors cannot claim back the tax, so there is no dividend tax advantage to holding shares in an ISA if you are a basic rate taxpayer.
However, higher and top-rate payers do not have to pay any additional dividend tax on their ISA share dividends, so they still stand to gain.
Watch out for charges on stocks and shares ISAs. Some funds levy an initial fee of up to 5%, plus an annual management charge of around 1%, which can eat into investment returns. You might also have to pay an adviser’s fees on top. But if you don’t need advice, you can probably buy your funds cheaper though a discount broker or a fund supermarket.
The Financial Services Compensation Scheme covers ISA investments up to £50,000 if your ISA manager should go bust. But remember, the FSCS does not compensate for poor performance.