Stocks and shares ISA and tax-efficient investing
As well as deciding what to invest in, it’s important to think about how you’re going to hold your investments. Barclays Stockbrokers offer a few different types of accounts and if you choose a tax-efficient one, you will often be able to keep a higher proportion of any returns you make.
You should always bear in mind that tax rules can change in the future. The benefit to you of favourable tax treatment from an ISA or pension will depend on your personal circumstances. For example, very few people are liable to pay Capital Gains Tax (CGT) as their gains may fall below an annual exemption level - known as the ‘annual exempt amount’. Barclays Stockbrokers doesn't offer advice, so if you need tax advice based on your circumstances, you should seek this independently.
If you hold your investments in an Individual Savings Account – ISA for short – you won’t pay CGT on any returns your investments make. Interest and dividends are also exempt from Income Tax. But the tax credit on dividend income received is not reclaimable within an ISA.
Your annual ISA allowance
Every year, the UK government sets the ISA allowance. For the 2014/2015 tax year, the ISA allowance for UK residents is £11,880.
There are 2 different types of ISAs available – a stocks and shares ISA, also known as an investment ISA, and a cash ISA. You can choose to hold up to the full allowance in an investment ISA or you can pay up to £5,940 (this will increase to £15,000 from 1 July) into a cash ISA and hold the rest in an investment ISA.
From 1 July, the allowance will rise to £15,000, the whole amount of which can be held in either a cash ISA or an investment ISA, or shared between both.
ISAs offer excellent tax benefits, provided that you do pay tax, and it doesn’t matter what tax band you’re in. So, if you’ve not already used your ISA allowance for the current tax year, it makes sense to hold your investments in an ISA.
You must be resident in the UK to hold an ISA, and you must be aged 16 or over to hold a cash ISA and 18 to hold an investment ISA.
Free from tax for now
By making the most of your ISA allowance every year, you could build up a large amount over time. There’s no limit on the total amount you can hold in an ISA, providing you stick within each annual limit.
You can think of it like building a house. Every year, you add a new row of bricks and eventually you have a tax-efficient shelter. And as legislation currently stands, you’ll not pay tax on any returns – now or in the future. Therefore, ISAs can be useful for saving for your retirement.
You always have to bear in mind that tax rules can change in future. You may have to change your investment plans if this favourable tax treatment changes or is withdrawn. The benefit to you of favourable tax treatment from an ISA will depend on your personal circumstances and these too can change 2.
If you don't pay tax then you won't benefit from an ISA, but you could in the future if you start paying it and the current ISA rules still apply.
Your ISA allowance – use it or lose it
Depending on what type of investments you hold in your ISA, you can usually take money out if you need to. But to get the most out of your ISA, it’s best to avoid this. That’s because once you withdraw from your ISA, you can’t pay it back in without using more of your annual ISA allowance.
For example, your annual ISA allowance for this tax year is £11,880 (increasing to £15,000 on 1 July). You pay in £9,000 then withdraw £4,000 a few weeks later, within the same tax year. Even though your balance is now only £5,000, you’ll only be able to pay in another £2,880 in this tax year. That’s because the £4,000 you withdrew still comes off your total annual allowance. If you want to pay more money in, you’ll need to wait until the new tax year and allowance starts on 6 April.
Pensions are another way of sheltering any returns you make from the taxman. They can be even more tax-efficient than ISAs because you either don’t pay tax on the money you pay in or you can claim back the tax you’ve already paid on it, up to certain limits. Either way, the money you put into your pension receives special tax treatment.
However, because a pension is designed to give you an income when you retire, there are some restrictions. For a start, you can’t take any money out until you reach the age of 55. There are also limits on the amount of pension contributions you can make and obtain tax relief on. These are known as the ‘annual allowance’ and ‘lifetime allowance’.
The 2014 Budget included significant changes to the rules for drawing benefits from pensions, to offer greater freedom. When thinking about investments, you should also consider your pension arrangements.
As with ISAs, the value of the tax benefits offered by pensions depends on your personal circumstances 2. Higher- and additional-rate taxpayers will benefit more from the protection from Income Tax and CGT. If you don’t pay tax, you won’t benefit from any of this favourable tax treatment. Pension legislation may also change in future.
Capital Gains Tax (CGT)
Capital gains are profits you make when you sell an investment at a higher price than you paid for it. Some of these gains are taxable. Every year, UK taxpayers have a CGT allowance, called the annual exempt amount. For 2014/2015, it’s £11,000. You’ll need to pay tax on any ‘chargeable gains’ you receive above this annual allowance.
The payable rate depends on your overall income, which includes any gains you make. The current rates are 18% for basic-rate taxpayers and 28% for higher-rate taxpayers.
Because the CGT allowance is set annually, many investors cash in their profits over time, rather than all in the same year. By doing this, they avoid going over their annual allowance and paying CGT. However, if you hold your investments within an ISA, you don’t need to do this because any gains made within the ISA are free from CGT.
It's always worth thinking about whether you’re making the most of your tax allowances when making your investment decisions. Remember too that tax treatment depends on your individual circumstances and you should seek independent taxation advice tailored to you.
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2. Tax rules can change and the benefits and drawbacks of particular tax treatment will vary with individual circumstances. We aren't a legal or tax advisor and aren't providing you with legal or tax advice. If you have any queries as to the legal or tax implications of any investment you should seek independent professional advice.