Understanding the Good and Bad Points of ISAs
Since this April (the beginning of the new tax year), the government has increased the ISA allowance, meaning you now have a bigger tax-free window to maximise your savings and investments.
Apart from the benefit of the tax-free allowance per year, ISA’s are highly flexible because they permit both lump sum investments as well as regular fixed contributions.
The ISA structure itself has been simplified – instead of the previous Mini and Maxi distinctions, now there are only two types, namely Cash ISA’s and Stocks & Shares ISA’s.
The following guide clarifies the main benefits and disadvantages of the two types of ISA’s, so you can be sure to choose the one that most closely suits your needs.
ISA Allowance Figures for 2011/2012
Until the next tax year, when the ISA allowance might again change, your total allowance is £10 680. Since the allowance limit is £5 340 for a Cash ISA, you can then put the remaining allowance of £5 340 into a Stocks & Shares ISA.
Alternatively, if you prefer not to have a Cash ISA, you can put the full £10 680 into a Stocks & Shares ISA.
For further information on the workings of ISA’s, you can view a useful video explaining the ins and outs of ISA’s at the MoneyWeek website.
Cash ISA’s
Pros
· They are simple to open and operate.
· The tax-free allowance works out to a 20% saving for basic rate taxpayers and 40% for those who pay tax at a higher bracket.
· You will have easy instant access to your money – bear in mind however that some Cash ISA’s have a notice period before you can withdraw your funds, so if you’re likely to need cash in a hurry, then make sure there’s no notice clause on your account.
· Income and capital gains from your ISA savings and investments are not taxable.
· Unlike Stocks & Shares ISA’s which can fall in value, you’re guaranteed not to lose money with Cash ISA’s. They’re just the same as savings account, but with the added bonus of your tax-free allowance.
· Cash ISA’s are open to anyone aged 16+, so they offer a good way to encourage saving from a young age.
Cons
· Cash ISA’s are most beneficial if you save larger sums of money. For example, if you put £500 into the account, your tax-free advantage will only yield a saving of a few pounds.
· Transferring Cash ISA’s from one bank or building society to another can be complex and time-consuming – there are numerous horror stories of these transfers taking months. For this reason many people have more than one Cash ISA.
Stocks & Shares ISA’s
Pros
· If you make the right investment choices, you can earn gains of 10%-20% per year with Stocks & Shares ISA’s, compared to an average of only 1% – 6% a year for their Cash counterparts. Thus you have the potential for much better returns.
· They offer lower tax on dividends. These are paid tax-free minus 10% (deducted by the issuer).
· You can not only invest in shares, but also bonds, unit trusts etc. This means you can effectively diversify your money into different asset classes.
· Your Capital Gains are 100% tax-free. While this won’t be a major boon if your ISA portfolio is worth less than £10,000, but it can add up to a substantial sum if you aim to increase your ISA investment over a long period.
· Stocks & Shares ISA’s allow you the flexibility to control where, when and how you want to invest.
· These types of ISA’s can provide a tidy tax-free retirement income. By using your yearly ISA allowance to invest in shares over many years, when you retire you can sell the shares and buy income producing assets such as income funds.
Cons
· The stock market is volatile, so there is no guarantee that your investments will rise in value – in fact they could fall significantly, leaving you out of pocket. This is why it’s important to choose your investments to match the level of risk you’re willing to take.
· In contrast to Cash ISA’s which don’t need to be monitored as they don’t rise and fall in value, with Stocks & Shares ISA’s the value of your investments is always changing, so you need to stay vigilant and know when shares need to be sold or others purchased to be effective at this game.
· You need to be careful about the accumulated repeat charges and fees involved in Stocks & Shares ISA’s as they can easily mount up and erode your investment gains.
· Some of these types of ISA’s have limited flexibility – be sure to steer clear of this since you want to have as many investment choices as possible to take advantage of the market.
· Tax is payable on cash held within a Stocks & Shares ISA and low interest is paid on your cash balances, so they’re not ideal for cash savings.
· We are all automatically given a Capital Gains Tax (CGT) allowance of around £10,000 per year. In addition, the losses of any shares you place in an ISA cannot be offset against the capital gains you make on investments held outside the ISA. Thus, unless you’re planning to invest a significant amount in your Stocks & Shares ISA portfolio every year to build up your assets, they’re not entirely worth it.
Conclusion
Whether you’re considering using your full ISA Allowance for Stocks & Shares, or simply want a Cash ISA account, both options have their advantages and shortfalls, as listed above. The basic deciding factor at the end of the day will rest on your individual preferences and circumstances
About the Author : George Pardew is an independent advisor on the ISA Allowance.
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