Money Basics - ISA
Money basics is a series of short articles where we will explore several themes that confuse and bewilder and try to break down all the legalistic jargon into plain English. Last week we discussed the best tax wrapper to hold your investments in, this week the (possible) second best.
What is a tax wrapper?
So once we’ve got this concept you’ll really start to be on the road to becoming your own IFA.
We call Pensions, bonds, ISAs, offshore bonds and certain forms of GIA “tax wrappers.”
A tax wrapper is the legislative contract that you wrap an investment within; gaining advantage of some of the perks of that investment wrapper.
The thing that actually makes the money is a mutual fund, or for some people, direct holdings. So, for a cash ISA the return of 1.25% is powered by a cash account which is wrapped up within an ISA wrapper.
An ISA is simply a tax privileged investment type.
So let’s look at some examples;
There are four main asset classes – fixed interest, Cash, Equities and Property
If they are invested outside of the ISA tax wrapper you’ll end up paying tax. If you’re a basic rate taxpayer you’ll pay income tax @20% on the cash, bond and property assets and 7.5% on the equity dividends.
As well as this you’ll pay capital gains tax on the sale of all of these funds.
If you place any of these assets within an ISA wrapper then neither of these taxes are due.
Here’s a table to make it a bit simpler:
Tax Free + tax relief
Tax Paying (as income tax)
Lifetime Allowance @ £1M from 6/4/16
This is a very simple table and there are exceptions to many of the above, for instance you can make an ISA inheritance tax free.
However, in general, a pension is the ‘best’ tax wrapper and the ISA is the ‘next best’ in terms of tax only.
What about endowments and peps?
All Personal Equity Plans were converted automatically to investment ISAs around a decade ago and are the same thing. Similarly with TESSAs.
Endowments are effectively a form of bond, however they are often ‘qualifying life policies’ which are slightly more tax efficient than their non-qualifying counterparts.
There are limits to ISAs aren’t there?
Like any good thing, there are downsides. You can only pay in £20,000 a year to an ISA. But our maths shows that no matter the value of your account; using a GIA and ISA is more tax efficient than any bond – however, there are exceptions here too.
Our in house Independent Financial Advisors can help you with all aspects of financial planning including pensions, investments and inheritance tax planning. If you need any legal advice, please contact the Chattertons’ Wealth Management team at your nearest office.