Why your Isa is a mini tax haven for ALL the family

GET TO GRIPS WITH ISAS

THERE is no point in jumping on the Isa bandwagon unless you know what they are or what they can do for you.

Do not be put off by the name. An Isa is simply a tax wrapper that lets you accumulate wealth free from the prying eyes of the taxman. You can use Isas to put cash into a savings account, invest in shares or funds, or save towards a home deposit.

You can even use the wrapper for ‘peer-to-peer’ investments, lending money to small firms and individuals in return for higher rates of interest, though this is not without risk.

Provided you do not break the rules – by paying in too much or opening too many accounts, say – all the returns your Isa accrues are yours. The taxman cannot touch them.

In nearly all cases, with the exception of the new Lifetime Isa for the under-40s, you can access your pot when you want without penalty. There is no income tax to pay on interest or dividends, and no capital gains tax to pay on profits. Also you do not have to declare them on your tax return.

It is yours and yours alone. Think of it as your mini tax haven.

KNOW THE RULES

THE maximum contribution that can be made into a tax-free Isa in this tax year is £15,240 for adults and £4,080 for under-16s. In the new tax year starting on April 6, these limits rise to £20,000 and £4,128 respectively.

Those aged 16 or 17 are especially lucky as they can have a Junior Isa allowance plus a cash Isa allowance.

Any unused Isa allowance cannot be carried over into the next tax year. If you have invested £10,000 in this tax year, say, but take no further action before April 5 you will lose the remaining £5,240 allowance.

So for those wanting to shelter money from the taxman, now is the time to act – use it or lose it.

WHAT TO DO

FOR those averse to risk, a cash Isa can be ideal. They tend to be offered by banks and building societies. But with interest rates so low, it is vital to dig out best deals. The table opposite shows the most competitive rates.

Sadly, unless you lock your cash into a fixed-term deal, you will be lucky to obtain interest above 0.9 per cent. With inflation at 1.8 per cent and rising, most Isa savers will see their cash pot eroded in real terms.

According to financial products scrutineer Moneyfacts the average cash Isa pays just 0.82 per cent interest. Anna Bowes, director of SavingsChampion, says cash Isa savers must keep abreast of the terms and conditions of any account they sign up to.

She says: ‘Many providers launch Isas with attractive rates that put them close to the top of the best buy tables. But the rate is often cut after 12 months. Savers need to make a note of this in their diary and be prepared to transfer their cash Isa to another provider when it happens.’

For example, Skipton Building Society pays 0.9 per cent on its Bonus Cash Isa Issue 7. But the 0.25 per cent bonus applies only to the first 12 months after which the rate falls to 0.65 per cent. Many savers have cash Isas that no longer pay competitive rates of interest – some as little as 0.01 per cent.

The rules allow you to transfer balances to a new provider – though not all accounts accept transfers. The table above indicates which of the current best-buys do. Such transfers do not affect your right to contribute to an Isa in the current tax year.

Transfers are organised by the provider receiving your money and should take no more than 15 working

days. Any longer and you will be entitled to lost interest.

Do not attempt to transfer the money yourself. If you withdraw funds from a cash Isa, even if it is with the intention of putting it in another Isa account, you will lose the tax-free protection.

Apart from the low interest rates on offer, another disincentive to taking out a cash Isa is the new personal savings allowance, which allows taxpayers to earn interest of £1,000 a year tax-free, or £500 for higher rate taxpayers. But bear in mind that the savings allowance could be withdrawn by a future Government, as could the generous Isa allowance. But surely no Government would risk attacking the tax-free status of money already accumulated in an Isa.

Also, remember that you can move money between cash Isas and stocks and shares (or equity) Isas, so putting money into a cash Isa now could open up your investment possibilities in the future.

RISK

FOR those in a position to think long term and who are happy to take some risk, a stocks and shares Isa may be the best way forward.

The most flexible of these are offered by online providers, such as Barclays, Bestinvest, Charles Stanley Direct, Chelsea Financial Services, Fidelity, Hargreaves Lansdown and The Share Centre.

Investors can pick which shares, trusts or funds to buy within the tax-wrapper. They can also set up a direct debit to drip feed their Isa – an effective way to invest when stock markets are fluctuating.

Some providers identify best-fit funds according to an investor’s attitude to risk. On pages four and five, Holly Mackay, managing director of the advice website Boring Money, looks at the best online Isa providers. On pages six and seven, we ask leading investment experts to disclose how they are using their Isa allowance. We also provide details of the most Isafriendly investment funds.

Experts say this month’s Budget changes to the tax-free income investors can receive from dividends make stocks and shares Isas a more compelling proposition.

The annual dividend-free allowance falls from £5,000 to £2,000 in the tax year starting April 6, 2018. Dividends above the allowance are taxed at 7.5 per cent, 32.5 per cent and 38.1 per cent for basic, higher and additional rate taxpayers respectively. But dividends received on investments held within an Isa are tax-free.

Those who do not want to put all their Isa allowance into stocks and shares can also contribute to a cash Isa, as long as the contributions stay within the £15,240 yearly total.

They can also use part or all of the annual allowance to invest in a peer-to-peer Isa, known as an Innovative Finance Isa. For more on this, see the case study, top right.

COMING NEXT

FROM April 6 a new type of Isa will be launched. It is called the Lifetime Isa and will sit alongside the Help-to-Buy Isa (see right), which savers will still be able to open until November 30, 2019. Both are aimed at young adults keen to put together a deposit to buy a first home.

Available to those aged between 18 and 40, the Lifetime Isa will let savers contribute up to £4,000 a year, which the Government will top up with a 25 per cent bonus until their 50th birthday. So someone saving the maximum £128,000 between the ages of 18 and 50 could receive bonuses of £32,000.

After 12 months, the Isa can be used to help buy a first home up to the value of £450,000. If the money is not used in this way, withdrawals are not permitted until age 60 without a 25 per cent penalty – effectively clawing back the bonus.

The Help-to-Buy Isa is less generous as contributions are capped at £1,200 in the first month, and £200 thereafter, though the Government still pays a 25 per cent bonus. Also, with the Help-to-Buy Isa, househunters outside London can only use the proceeds to buy properties up to a maximum of £250,000.

Savers with existing Help-to-Buy Isas will be able to transfer their accounts into Lifetime Isas once they are available, without the proceeds counting towards their £4,000 annual allowance.

Only those househunters who are over the age of 40 – and therefore not eligible for a Lifetime Isa – and those who are on the cusp of buying their first home should stick with the Help-to-Buy Isa.