With less than two weeks to go before the 2009 tax year ends and the new one begins, investors are being urged to take full advantage of any outstanding Isa allowance that remains unused.
As the government battles to deal with the huge budget deficit, taxes are due to rise and Isas are one of the only methods that savers can use to avoid paying more to the tax man.
At present, all savers under 50 can invest up to £7,200 into Isas within the 2009 tax year, while those aged over 50 can invest up to £10,200. The increased limit will become effective for everyone else from April 6.
However, many savers are missing out on their tax free savings allowance, with net sales at £174m in January, according to the Investment Management Association — below the level recorded in December.
There are a number of myths that have been associated with Isas, so we have explored nine of the most common misunderstandings in order to inform investors so they can make the right choices before this years Isa allowance
deadline is reached.1. ISAS ARE NOT WORTH THE HASSLE DUE TO LOW RATES
You may not think an annual Isa allowance of £7,200 is much, but if you invest this every year, you will soon begin to see the benefits, especially with the allowance increase.
For example, if Jack and Jill, both 50, invested the full amount every year in personal equity plans (Peps) and Isas since 1987, they would have now have saved £343,200. Assuming this was earning them a 5% return, the pot would have grown to £604,000 — with nothing paid on capital gains tax (CGT). With the new limits in progress, if a couple were to each invest their maximum Isa allowance of £20,400 a year for the next 25 years, again assuming a 5% return, this could grow to a massive £1.022m.
Sam Gooch, savings expert at Which4U said: “If you look at how much you could earn from a single years Isa allowance, you're unlikely to begin making big plans with the returns, but keep adding to this pot and stay on top of the best Isa rates, and you will soon be able to see some very appealing results
“We [at Which4U] currently have clients that have managed to save over £100,000 in their Isa portfolios, and with the Isa limit now increasing to £10,220 per year, you will soon see that it won't take you very long to build a substantial tax-efficient investment portfolio.”
2. IF YOU FAIL TO USE UP YOUR ISA LIMIT BEFORE APRIL 5 YOU WILL LOSE IT
The majority of fund managers offer a “cash reserve” facility that allows you to park your Isa allowance until you are ready to invest it in the market. When you decide the time is right, you can drip feed your funds into shares, allowing you to avoid missing out on any Isa allowance.
For example, Fidelity provides a cash park service, but the rates offered are lower than the market average, with Fidelty’s standard Isa Cash Park rate fixed at 0.4% below Bank rate before tax, which would currently be just 0.1%. However, the rate will be fixed at 0.2% below Bank rate until June 30.3. TAXPAYERS THAT FALL WITHIN THE BASIC-RATE BRACKET SHOULDN’T BOTHER WITH ISAS
Gordon Brown removed the 10% dividend tax credit from equity Isas
in April 2004, which means that basic-rate taxpayers (earning £0-£37,400) are no better off investing in equities inside an Isa wrapper than outside. Higher-rate taxpayers will still avoid paying 32.5% tax on dividends (due to rise to 42.5% from April).
However, although equity Isas hold far more benefits to higher-rate taxpayers, basic-rate taxpayers can still save 20% income tax from fixed-interest (bond) funds.
In addition, Isas do not have CGT deducted. Even if the returns you make are currently less than the current CGT allowance of £10,100, as your investment grows, you may face a bill in future if you fail to invest within an Isas wrapper.
Danny Cox of Hargreaves Lansdown, said: “Basic rate taxpayers pay the same rate of tax on dividend income either in or out of an Isa. However, Isa income does not reduce the additional age-related allowances for the over-65s [£9,490]. For those with income of between £22,900 and £28,930, the allowance is reduced by £1 for every £2 of income — unless it is from an Isa.”
Those currently on basic-rate tax can also save 20% tax that would otherwise be deducted from savings interest. 4. ALWAYS DECLARE YOUR ISAS WHEN FILLING OUT YOUR TAX RETURN
Details of Isa investments are not required on your self-assessment form.
5. YOU CAN ONLY HAVE ONE ISA AT A TIME
Although your Isa limit is £7,200 (of £10,200 for over 50's and for all on 6 April) you cannot invest the full amount into a cash Isa
, with the maximum amount capped at half of the total - £3,600, with the option to invest the rest into a stocks and shares Isa. However, you can use the full limit to invest solely into a stocks and shares Isa, or a combination of the two.6. YOU CAN’T OPEN A NEW ISA AND TRANSFER AN OLD BALANCE ACROSS
If you have cash Isas from previous years that are earning low rates of interest, consider transferring them to another higher paying Isa without having an affect on your annual tax-free allowance.
However, when doing so make sure you do not withdraw the money from your cash Isa yourself in an attempt to move it elsewhere, or your investment will lose its tax-free status. Instead you must contact your Isa provider and fill out a transfer form.
Not all providers accept transfers, so ensure you read up before opening your ISA. The current best deals that accept transfers include the RBS Isa
, which pays 4% on its 3 year fixed rate Isa. If you wish to find the best Isa rates for instant access accounts, you may wish to consider the Alliance & Leicester Isa
, offering 2.75%.
You can also transfer funds from a cash Isa into an equity Isa, but you cannot move from an equity Isa into a cash Isa.7. YOU CAN INVEST IN ONLY ONE FUND WITHIN YOUR ISA
You can split up your £7,200 allowance and invest across a range of different funds using a fund supermarket.
Fund supermarkets allow investors to shop for funds online from a number of managers. As they buy funds in bulk, these supermarkets are able to get some significant discounts which are generally offered on initial charges. Fund managers tend to impose initial charges of up to 5%, but you can avoid paying these high charges by going through a fund supermarket, with charges reduced to around 1.5%.
Nowadays you can choose from several fund supermarkets, with the largest including Fidelity’s Funds Network, Cofunds, and Skandia Investment Solutions.
Cox said: “No one investment company offers brilliant funds across their whole range. The main advantage of a fund supermarket is that it is independent and offers much wider choice, meaning the potential for much better performance.” 8. IF YOU MOVE ABROAD YOU MUST CASH IN YOUR ISAS
If you plan to move overseas and stop paying tax in the UK, you will not be able to open an Isa. However, all previous years Isas can remain active. Philip Pearson of Southampton-based P&P Invest said: “If you move away from the UK then your Isas can stay in place and continue to provide a tax efficient means of capital growth and income into the future, within a legitimate tax haven in the UK.”9. ALWAYS OPEN AN ISA CLOSE TO THE NEW TAX YEAR
It isn't untrue to say that there are some very attractive Isa rates available in the Isa season but you should never hold back for this reason alone.
Mr Gooch said: “If you want to invest some capital it makes no sense to wait until the tax year is nearly over to do so. In fact, if you were to wait until the last minute every tax year you could end up missing out on a full year of tax-efficient investment growth — something that can easily outweigh the best Isa rates available over this period.”
Darius McDermott of Chelsea Financial Services, the discount broker, said: “One simple way of removing the temptation to time markets is to save on a monthly basis and achieve what is known as 'pound cost averaging' [buying more units when prices are lower], which helps greatly to smooth out volatility.”
10. YOU MUST PAY FULL CHARGES ON YOUR ISA
You should only be paying the full charges for Isa funds if you are currently receiving advice and ongoing service from an adviser. Gooch said: “The majority of the initial charge on Isa funds is used to pay for the adviser. There is usually a 0.5% charge from the annual management costs which is used to pay for ongoing service and advice. If you don't receive this advice, you should demand a discount. There is a typical 1.5% annual management charge, of which 0.75% is for the fund manager, 0.25% for the Isa platform and 0.5% for the adviser.”
If you don't require advice, consider a discount brokers such as Chelsea Financial Services, who have access to 1,200 funds with no initial charge.
Written by Sam Gooch