Myth two – The Dividend and Personal Savings Allowances mean ISAs aren’t worth bothering with
One of the main attractions of ISAs is that any money you make is tax-free. However, there are other tax allowances which mean you won’t necessarily pay tax on savings and investments that are held outside of an ISA, leading some to believe ISAs aren’t worth bothering with.
For example, you can receive up to £2,000 a year in dividend income without paying tax. This might be adequate for many people, but if you build up an investment portfolio over many years, you may find that the amount you receive in dividends exceeds the annual allowance. If that happens, basic-rate taxpayers must pay 7.5% on any dividends above the £2,000 allowance. Higher-rate taxpayers pay 32.5% and additional-rate taxpayers pay 38.1%. ISAs help protect against this risk.
Similarly, gains on investments are liable to capital gains tax (CGT). The standard CGT rate is 10%, while the higher rate is 20%. You have a CGT allowance every tax year – it’s currently £12,300 which means if you sell any investments, you’ll only pay tax on profits above that amount. If your gains are less than that, or you plan carefully and stagger the sale of your investments over a number of years, you can avoid CGT. But if you invest within an ISA, you don’t have to worry about the amount of profit you may have made when you want to sell as CGT won’t be applicable.
Another allowance, the Personal Savings Allowance (PSA), enables you to earn interest on your savings income without paying tax. Basic rate taxpayers can earn up to £1,000 in interest each year tax-free, and higher rate taxpayers up to £500. Additional rate taxpayers don’t have a PSA. You’ll pay income tax on any interest above these amounts, unless your savings are in a cash ISA in which case all interest will be tax-free. This savings income covers several different kinds of investment income.
Myth three – You can’t take money out and pay it back in
If you hold money in an ISA, you can take it out and pay it back in within the same tax year without it affecting your annual allowance.
For example, if you’ve used £10,000 of your ISA allowance this tax year, and take out £2,000, you could put it back in before the tax year ends on 5 April, and still be able to pay in a further £10,000 – the remainder of your £20,000 allowance. Not all ISA providers offer this flexibility though, so check with yours before withdrawing any money.
Myth four – You must decide which funds or investments you want to hold in an Investment ISA before you can open one
If you want to invest this year’s allowance in an investment ISA, but haven’t yet decided where to put your money, you could pay it into the ISA but keep it as cash until you’ve made up your mind. The ability to hold cash in your Investment ISA can also be useful if you’re uncertain of market conditions and don’t want to invest immediately.
If you do decide to leave your money in cash, it is easy to forget about it, so perhaps set a reminder to come back and decide what to invest in. If you are struggling for ideas we have some ready-made portfolios, managed by our experts, suitable for investors of differing risk levels.
If you are unsure if now is the right time to invest, this is understandable but bear in mind that it will likely never feel like an ideal time to invest. There is always some bad news around which may influence our views and this can lead to missing out on longer-term investment growth. In this case, you may want to think about setting up smaller regular automatic investments. Then you will not have to invest all at once, the price you pay will even out if there are short-term falls in value, and you don’t need to get comfortable every time you invest. While there can be benefits to investing regularly rather than as a lump sum, you should remember the impact fees have on your investment. If you’re only investing small amounts each month, the minimum monthly fee could make it expensive and may exceed returns.
Myth five – Once you’ve chosen an ISA, you’re stuck with it
ISAs have become more flexible in recent years - it’s possible to change ISA provider and switch from cash to investments and vice versa.
You just need to make sure that the ISA you want to move to accept transfers, and check you won’t be charged a penalty, suffer any other detriment or lose any benefits from your current ISA provider if you move.
If you’re looking to transfer money you put into your ISA in a previous tax year, you don’t have to move it all. So for example, if you have £40,000 in a cash ISA and want to start investing, you could transfer some of it to an investment ISA and leave the rest in your cash ISA.
However, if it’s money you’ve paid into your investment ISA during the current tax year, you’ll have to transfer the full amount.
If you’re thinking of transferring money from a cash ISA and investing it, make sure you’re comfortable with the additional risks associated with investing. The value of investments can fall, although investing offers the potential of generating higher returns over the longer term, but you may also make a loss.
Please bear in mind that this article is for general information purposes only. If you’re unsure, seek professional financial advice.