Individual Savings Accounts – or ISAs as they’re usually known – are everyone’s ticket to ride the tax-free savings train. As UK citizens, we are all entitled to save a certain amount each year into ISAs and, by doing so, we avoid giving up part of the proceeds to Her Majesty’s Revenue and Customs. By placing your allowance into an Investment ISAs, as opposed to just Cash ISAs, you could stand to profit far more out of the arrangement.
Fundamentally, this is because Investment ISAs involve using your tax-free allocation to buy stocks and shares in publicly listed companies or other approved fluctuating assets such as commodities or bonds. While this entails a risk of the investment going down in value as well as up, the potential returns can far outstrip anything on offer with the cash ISA alternative.
Those with larger sums in the Investment ISA portfolio – the result of topping up to the maximum level year on year – also stand to benefit from no Capital Gains Tax, as well as the income tax respite, over and above the £10,900 per year we are all entitled to as standard.
No longer a ‘rich man’s game’
To begin with, it’s worth explaining a few changes in the market which make Investment ISAs a viable option for everybody, and not just high earners, as the case may previously have been. Essentially, the charges on Investment ISAs used to be much higher than they were on normal investments. For some investors, especially those in the lower tax rate bracket, this meant that the savings they made by not paying any tax were offset by the charges they faced for management of the account or making trades.
Now, though, the costs involved with Investment ISAs have been lowered to the same levels as normal investments. This is partly a result of the proliferation of ‘passively managed funds’ now on the market. Often known as ‘trackers’, these products involve autonomously buying shares on your behalf across an entire market place so that your profits reflect the overall trend of that market. This is compared with actively managed funds, where a human fund manager rather than a computer is making decisions about where to invest your money and takes a much more measured approach. Clearly this is more expensive, but those with more complex investing strategy will find their needs more personally catered for.
Another reason prices are coming down is the introduction of ‘fund supermarkets’. These offer brokers the chance to buy into multivariate investment portfolios (open-ended unit trusts and open-ended investment companies) and receive a commission on the sale. Since the broker makes money through other means, the charges to the investor should naturally be lower. Furthermore, the theory is that the investment arms of the high street banks are forced to lower their own management fees in order to compete.
Scenarios for investing into cash and investment ISAs:
Scenario A: £5,760 into Cash ISA, £5760 into an Investment ISA = total investment of £11,520 (maximum 2013/14)
Scenario B: £3,000 into Cash ISA, £8,520 into Investment ISA = total investment of £11,520 (maximum 2013/14)
Scenario C: £3,000 into Cash ISA only = total investment of £3,000
Scenario D: £10,000 into Investment ISA only = total investment of £10,000
How much can you invest?
From April 6, 2013, our yearly ISA limits increased to £11,520 per person – a 2.1% rise on the previous tax year. Anything up to this amount can be allocated to an Investment ISA. Alternatively, the allowance can be split so that up to half (£5,760, to save you the maths) is paid into a regular Cash ISA, and any amount of additional funds from the remainder of the allocation can be paid into an Investment ISA, should you choose to do so. The Cash ISA works just the same as a common or garden variable or fixed savings account – your money is not at risk but the interest rates on offer are much lower.
How many ISAs can you have?
You are allowed to have as many ISAs as you choose. However, you can only pay into one of each of the two types of ISA per tax year – that’s April 6th to April 5th over any given 12 month period. In addition, you can only hold one of each type of ISA with any given financial institution. So, if in the 2012/2013 tax year you decide to invest money into an ISA with one bank, when the 2013/2014 tax year rolls around you can choose either to top up that same ISA with the same bank or you can open a new ISA with a new bank.
You are also at liberty to transfer the entire balance from your ISA with one bank to a new one with a second bank – even if it has a total of several years’ worth of investment within it – and you won’t affect your allocation for that particular tax year.
Investment ISA options
There are generally two different ways to manage your Investment ISA. Firstly, you can opt for a self-select account where you choose yourself which stocks and shares your money is invested into. You can pull the money out of some of the assets and place into others as you see fit. The second option is to choose a managed fund account. Within this, you can choose for the passive management account where you essentially track a whole market, or an active management account where a fund manager decides which funds to invest your money into.
If you opt for a self-service account you will need to decide your own risk profile and regulate yourself to stick to. Depending on the institution you choose for your account, you’ll get a certain level of information on which investments constitutes low, medium or high risk and it will be up to you to spread your money around. Even if you are happy with a high level of risk, it is certainly advisable to spread your money out over multiple investments, including some safer options to ‘hedge your bets’.
If you opt for the managed route, the financial adviser from your chosen institution will do this on your behalf, as per your instructions for your selected risk profile.
While there might not be tax to pay on your gleanings from your Investment ISA, there will still be operational fees payable to the bank or asset manager you deal with. This is because the banks and fund managers are not receiving the benefit of holding your money like they do with Cash ISAs – instead it is being spread around third party stocks and shares.
The charges you can expect to pay, depending on what type of management you opt for, include:
- Annual management fees
- Scheduled investment fees
- Individual trade fees
- Transferring of cash in and out fees
Unfortunately there are no hard and fast rules on what these charges are or how they are calculated. Some providers opt for flat fees (i.e. £10 per year administration, £5 per trade) while others impose a percentage fee (i.e. 1.5% of your portfolio per year for management, 5% of each trade).
As mentioned earlier, the costs have come down considerably in recent times and many companies offer free administration in order to win your business. Shopping around is imperative.
Who deals in ISAs?
Providers of ISA accounts need to be registered with Her Majesty’s Revenue and Customs (HRMC) and regulated by the Financial Services Authority. They range from established specialist wealth management companies to the investment arms of high street banks to start-up self-service management platforms. HRMC keeps a regularly updated list of all authorised ISA management companies which you can access here.
Where can your money be invested?
The company that you deal with will determine which types of assets you can buy to include within your investment portfolio – they don’t all have access to the same stocks or even the same types of investment. What they offer varies greatly between corporate bonds, company shares, unit trusts, open-ended market companies, equity growth plans, exchange traded funds and all of the individual recognised trading markets for each of these. As mentioned earlier, the relatively recent addition of ‘fund supermarkets’ alleviates this problem to a certain degree as they have access to a wider range of stocks than any individual trading house.
Even if you are looking to manage your own stocks and shares portfolio with a self-management platform, it is always advisable to seek advice from an Independent Financial Advisor.
Click here to see a host of leading Investment ISAs currently on the market with Know Your Money’s comparison tables.
Author: KYM Editor