Published on 15 March 2011
I often refer to an Investment ISA as an “overcoat” or “wrapper” which protects the contents from personal taxes. Just as an overcoat can be worn over ordinary clothes and can protect the wearer from inclement weather, so an ISA can be used to wrap-around existing investments to protect them from tax. These "overcoats" come in many different shapes and sizes. We even have 15 clients who have investment ISAs valued in excess of £1,000,000! Whilst tax rules remain the same, this means they will never have to disclose even a penny of these funds on their tax returns.
ISA millionaires are of course as rare as hens' teeth. However the fact they exist at all underlines the huge potential of these accounts. These clients, and others with high value ISAs, have realised that they should not be regarded as one-off tax saving accounts but rather as long term fiscal planning tools.
An ISA history
The origin of Investment ISAs can be traced back 24 years to 1987 when the first PEP1 was introduced. The modern ISA could be an amalgamation of previous years PEPs, TESSAs2 and or Cash ISAs as, even though the first 3 do not even exist any more, their legacy lives on as you could have transferred them into the ISA you own today.
Speaking personally, my first contribution, into what is now my current ISA, was a payment of £3,000 into a single company PEP back in 1992 and I have tried to make contributions each year since, 5 children and 1 divorce permitting! I have been asked many times before how much tax I have saved by using ISAs. I am not so much of an anorak to have tried to work this out and my answer has always been "hopefully not as much in the past as it will save me in the future". In this rather flippant remark lies the real potential - the possibility that all the funds held within the ISA, today and in the future, will not have to be declared on my tax returns for the rest of my life. No one knows what the basic and higher tax rates will be in the future but I am old enough to remember a 98% tax rate so perhaps I appreciate more than most the pain of high taxes.
It is not just the value of our clients’ ISAs that varies, the reasons why they have them and the way they are used can also be very different. They fall into different categories and although they are not mutually exclusive they are relatively distinct.
Why have an Investment ISA?
1. To reduce basic rate tax liabilities.
This is not the forte of the ISA as the 10% tax credit deducted from ordinary shares is not refundable. However, if this is your over-riding objective then you can still achieve it by investing in asset classes that are not liable to pay this tax in the first place for example; Gilts, Corporate Bonds or REITS (see previous Corner
). In my view any balanced portfolio should include some money invested in these types of investments so it is really a question of having the right type of investments in the right type of account.
2. To reduce higher rate tax liabilities. To me this is the greatest benefit of the investment ISA. The basic rate tax band has been reduced in the new tax year from £37,400 to £35,000 thus increasing the impact of the 40% tax band. However, you must remember that, at the same time, the personal tax allowance (in effect your nil charge band) will increase so it will be people with income in excess of £42,475 who will pay higher rate tax. This change alone according to estimates will increase the number paying higher rates of tax by about 700,000.
Income from investments held within ISAs is of course ignored for this calculation and is not liable to this tax.
3. To reduce capital gains tax (CGT) liabilities. This is also a significant benefit of Investment ISAs. Many people feel that the annual allowance for CGT, £10,100, allows them to manage this position without incurring liabilities. I think this is true to some degree.
For example many people used to tell me they could not sell their bank shares as the CGT payable would have been too great. Now of course they wish they had diversified and paid the liability. I totally understand their position, who would have thought that blue chips like the banks could have been hit by such a crisis? The point I want to make is that if they held these shares in an ISA in the first place they would not have to take into account any tax considerations whatsoever. They could have managed their shares purely on their investment merits.
4. To make your life easier! I really think that people should try to make their lives as simple as possible and this includes their investment and tax positions. Why complicate your life with capital gains and higher rate tax calculations on your investments. Use your ISA and you will not need to!
But bear in mind, the investments you hold in your ISA can fall in value and you may get back less than you invested. Generally, they should be used as a way to invest for the medium term and you should aim to hold your investments for a minimum of five years. It is important to note that tax rates, ISA regulations and the basis of taxation can change and the impact of tax will vary depending on your individual circumstances. Our Investment ISA is available to investors over 18 years old who are UK resident.
How will your ISA keep you sheltered from the elements this year?
1. The income seekers overcoat! If you invest in gilts, corporate bonds, REITs (individual or funds) or high-yielding equities inside an ISA you will receive the income gross and it will remain tax free (bearing in mind the 10% tax credit deducted from ordinary shares is not refundable).
2. The practical poncho for the international traveller!
By using Exchange Traded Funds (ETFs)
you could track overseas market indices or by using managed funds you could invest in international markets while accessing professional management (see also free ISAs below).
3. The buy and hold jacket for the discerning investor! Traditional buy and hold investors can often find that CGT can become a problem in the long term. Investing in shares inside an ISA means that any capital gain is totally exempt from tax.
4. The commodity cape!
Many clients now hold commodities such as gold or oil in their ISAs. Have a look to find out the options in my previous commodity piece
in the archive.
5. The speculator's mac! Many of the highest value ISAs I have come across have not followed one of the most basic rules in investment – do not put all your eggs in one basket. Instead clients have invested in one company and in some cases the shares have done exceptionally well.
For example, if you had £40,000 in your ISA in 2006 and you invested in the FTSE 100 company, Aggreko (AGK) on 13 June 2006 you would have achieved growth of over 700% giving you approximately £250,000 now (excluding dealing charges). In normal circumstances a sale of such a stock would incur a massive CGT bill but not in an ISA. You could sell and reinvest and diversify or simply take your money and spend it. Either way it will be totally tax free.
The downside of putting all your eggs in one basket, or in this case all your money in one company, is that you have obviously significantly increased the risk. For example if you had invested the same £40,000 into RBS your investment would have dropped over 90% to about £4,000 in the same period.
For this reason it is not something that I would consider but sometimes increasing the risk does achieve greater returns. When it comes to your overall portfolio I would always recommend diversification and follow what I call the 10-2 rule - not more than 10% in one stock and not more than two stocks in the same sector. Maybe that is why I will never be an ISA millionaire!
6. The fee-free tailcoat! The normal annual administration fee for our Investment ISA is £30- £50 plus vat depending on the overall value of your portfolio. This may be a very small percentage charge when your investments have built in value but in the early days it can understandably put people off. If this is the case it is worth remembering that if you hold only managed funds from our Funds Market, and cash, in your ISA, no administration fee will be charged, giving you a fee-free ISA.
Our Funds Market has over 1,000 funds available at huge discounts, some available at 0% initial charge* including Barclays Wealth Global Markets funds, and all the tools you need to help you choose the right ones.
As you can see ISAs are many different things to many different people and in my view they are truly a coat of many colours. However, remember the risks: Investment ISAs’ values can fall. You may get back less than you invested.
*There will be annual management charges made by the fund managers.