Why invest in a stocks and shares ISA?
Anyone who plans to put their money away for 5-10 years or more should consider investing in the stock market. In that case your priority should be to put the first £20,000 each year into a stocks and shares ISA: there’s no tax on gains or dividends, and any withdrawals you make are also free of tax.
If you invest outside the ISA wrapper, this year, the first £2,000 of dividends are tax free and the rest are taxed at 7.5% for a basic rate taxpayer, 32.5% for a higher rate taxpayer, and 38.1% for an additional rate taxpayer. There is no guarantee that the dividend allowance will stay at £2,000 – or remain at all – given that it has already been cut from £5,000 since it was introduced in 2016. If you invest within an ISA, by contrast, all dividends will always be tax free.
There’s no tax on capital gains either. Outside the ISA you’ll pay tax on any gains during the year that exceed your annual allowance – which this year is £11,700. After that, basic rate taxpayers will pay 10% tax, and higher and additional rate taxpayers 20% on gains.
What other tax efficient investments are there?
There are more tax-efficient investment vehicles available: Venture Capital Trusts (VCTs) offer 30% income tax relief on all money invested (as long as you hold them for at least five years). However, VCTs are specialist vehicles that invest either in unquoted companies or Aim stocks, which can be much riskier than established, quoted businesses. As such, they are only suitable for the most sophisticated investors, with the ability to absorb losses.
There are also specific investment objectives for which other investment vehicles offer superior benefits. If you’re investing for retirement, you can put up to £4,000 a year into a Lifetime ISA (LISA), and get a 25% top-up from the Government on all contributions. The money will then grow tax free, and you can take a tax-free income from the age of 60. If you are a self-employed basic-rate taxpayer, a LISA may be the best option for retirement savings. However, for the vast majority of people, a pension is a better bet, especially if you are employed, because your employer usually has to contribute to the pension too.
Instead of becoming the main vehicle for retirement, in most cases ISAs play a useful role alongside the pension, offering flexibility. They can, for example, enable you to manage how you take an income in order to remain below the higher tax threshold. Alternatively, if you phase retirement, you might want to keep contributing more than £4,000 a year to your pension, so you don’t want to want to take an income from your pension and trigger the money purchase annual allowance. If you have ISAs alongside your pension, it enables you to generate an income from those instead.
LISAs have a far less ambiguous role in saving for a first property. The government top-up offers up to £1,000 a year towards your property deposit, which far outweighs the potential gains from any other kind of savings or investments. Any prospective first-time buyer aged 18-39 who has at least a year before they intend to buy should consider a LISA. If you are too old or too young, or you want to buy sooner, you can use a Help to Buy ISA. These have a lower maximum investment and bonus, and offer less flexibility, but still offer a 25% government top up on contributions.
Another member of the ISA family offering significantly enhanced benefits is the Junior ISA. This came in the wake of the demise of the Child Trust Fund (CTF), and like the CTF offers tax-efficient investment in return for tying the money up until the child is 18. The JISA is superior in a number of ways, as it tends to offer better interest rates on cash, more investment choice, and lower charges.
Both are less flexible than investing for a child through a bare trust, because money in a trust can be cashed in at any time – as long as it is used in the best interests of the child. In many cases, money in a bare trust is also effectively tax-free, because it is taxed as belonging to the child. However, the exception to the rule is where the money is invested by parents and income on investments is £100 or more, in which case it is taxed as belonging to the parent. If there’s a risk you will breach this limit at any stage. it’s well worth considering a JISA instead.
Five top ISA funds for 2019
Lindsell Train Global Equity
The fund aims to invest in the best companies in the world. The managers look for companies which don’t have too much borrowing, that produce high and stable returns and operate on higher than average margins. Of all the companies in the world they have identified 180 of them and invested in 25-30 of their favourites. By focusing on the fundamentals, the managers pick companies that they expect to continue to deliver throughout the economic cycle. Lindsell Train Global Equity
Crux European Special Situations
Europe has been overlooked for years by investors, but markets have generally performed well, and while Europe has its challenges as a region, it is home to successful businesses with global earnings – many of which tap into growth in faster-growing regions of the world. Fund manager Richard Pease is one of the most respected managers in the region, and while there are no guarantees, he has experience of performing well during difficult periods. Crux European Special Situations
Legal & General UK Index
Investors have become more nervous about trading conditions in the UK, but the market itself is home to an enormous number of companies with international earnings. So, while the domestic outlook is mixed, many of these multi-nationals will continue to perform well. They may even benefit if there is more weakness in sterling. This fund is a useful way to get exposure to the index at a very low cost. Legal & General UK Index
Jupiter Global Value
Ben Whitmore, head of strategy at Jupiter Global Value is a contrarian investor, seeking out opportunities in unloved areas of the market. His approach has served him well in the UK for 20 years, and while his track record on a global basis is relatively short, his disciplined approach inspires confidence. It’s one for more adventurous investors, who are willing to be patient and accept it could be a bumpy ride, in return for potential growth. Jupiter Global Value
We rate fund manager Adrian Frost and the Artemis UK Equity Income team. They have significant experience and a long history of out-performance. They consistently look for companies that generate cash and can reliably increase dividends. The focus on unloved areas of the market mean there can be periods of under-performance, but for those prepared to stick with this investment it has great potential for long term growth. As such it makes a useful core holding for a long-term portfolio. Artemis Income
Why invest in a cash ISA?
Cash ISAs make a great deal of sense for anyone who is saving for something within the next five years or are putting money aside for emergencies. They’re also a useful place to hold the cash portion of a portfolio.
The number of new cash ISAs hit an 18-year low last year, largely because of the advent of the savings allowance, which means the first £1,000 of interest earned by a basic rate taxpayer (£500 for higher rate taxpayers) is tax-free. It encouraged people to question whether cash ISAs were worth bothering with – especially because at the moment cash ISAs tend to pay marginally less interest than their equivalent savings accounts.
However, there are still good reasons for protecting your savings from tax for life. If there’s any possibility your income will rise, interest rates increase, or government policy changes and the savings allowance is threatened, sheltering your savings permanently from tax within a cash ISA is well worth considering. Bear in mind also that ISA savings are cumulative, so over the years the sum protected from tax will really add up. And if you shop around, you can easily find a best-buy cash ISA paying more interest than a typical high street savings account.
|Charter Savings Bank||1.4||Charterhouse Savings Bank|
|Virgin Double Take E-ISA||1.4||Virgin Money|
|Leeds Building Society Online Access ISA||1.38||Leeds Building Society|
|Al Rayan Bank Instant Access ISA||1.36||Al Rayan Bank|
|Post Office Money Online ISA||1.35||Post Office|
Sarah Coles is personal finance analyst at Hargreaves Lansdown