Stocks and shares ISAs
ISA originally stood for “individual savings account” but now has basically become a word in its own right.
There are many types of ISA – cash ISA, junior ISA, help to buy ISA, innovative finance ISA… the list goes on. But here, we’ll focus solely on the ISA most relevant to investing: the stocks and shares ISA
A stocks and shares ISA is a financial product within which you can hold your investments.
Products like this are sometimes referred to as “wrappers”. They are not investments in themselves, but are accounts that wrap around your investments like cling film and provide certain features and protections you wouldn’t otherwise get.
Most mainstream investment products (open-ended funds, investment trusts, unit trusts, exchange traded funds) can be kept in a stocks and shares ISA, as well as gilts (government bonds), corporate bonds, and individual shares. It’s also possible to hold cash in a stocks and shares ISA, although you won’t be paid interest on this at the same kind of rate you would get with a cash ISA. The intention is that the cash is held there until you decide how to invest it, not as a long-term savings cache. You can’t hold direct property in a stocks and shares ISA.
You’ll usually pay a one-off set-up fee to open an ISA with an online provider, which could be between 4 or 5 per cent of the total you’re investing initially. Then you’ll be charged a small percentage of the value of your pot as an annual fee. This will vary depending on the provider but really shouldn’t be more 1 per cent. AJ Bell Youinvest, for example, charges 0.25 per cent. Hargreaves Lansdown charges 0.45 per cent.
This will be in addition to the fees you pay to the managers of the actual funds you hold.
The big appeal of a stocks and shares ISA is its freedom from capital gains and income tax. Normally, if you sold investments at a profit you would have to pay capital gains tax on the difference in price (above a certain threshold, on which more later). Similarly, you would have to pay tax on any dividend or bond income above a certain amount. However, the assets within an ISA are exempt from any tax as they grow or when you take your money out.
Note that you will have already paid tax on the money you put in to an ISA. This is one difference between an ISA and a pension: ISA money is taxed on the way in, while pension money is taxed on the way out.
There are loads of ISA products available. Whoever you’re buying your investments through will probably have one available. Investment ISAs differ from cash ISAs because instead of looking at the rate of interest you’ll be paid and how long you have to lock your money away, you’ll be looking at how much they will cost you in fees. Your growth will in theory come from your investment returns, not interest paid by the ISA provider.
The biggest risks of using a stocks and shares ISA come from the actual investments themselves. As opposed to cash, the value of investments can and will fluctuate unpredictably. While investors hope to beat inflation over the long term, losing money is a very real prospect. This is not a savings product and shouldn’t be where you stow your emergency money.
If you’re going to be investing anyway, there aren’t really many downsides to doing so in a stocks and shares ISA. Unlike a cash ISA, money in a stocks and shares ISA isn’t locked away. Growth and time horizon are instead all to do with your investments.
Unlike investing outside of a wrapper in a general investing account, there is a limit to how much you can put in an ISA each year. The current ISA limit is £20,000 for the 2018/19 tax year.
It’s not so much a drawback, but it is possible an ISA won’t be of much use to you if you’re not investing a large sum of money. The allowances for both capital gains tax and dividend tax are pretty generous: you’re not charged capital gains on the first £11,700 in profits for the 2018/19 tax year, and you’re not charged dividend tax on the first £2,000 of dividends you earn either. Because dividends are usually only equal to a small percentage of the amount invested, you will probably have to have at least 10 or 20 times that amount invested before you begin to earn dividends anywhere near to the allowance.
And remember, capital gains tax only applies when you sell your investments at a profit – not if you continue to hold them even if they increase in value.
One thing to note here is that these allowances are subject to change from one year to the next, be it for political, economic, or other reasons. If you have your money inside an ISA you won’t be taxed even if the allowances are lowered or abolished – as long as the ISA rules remain in place.
Warning: The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results.
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