With the introduction of the Personal Savings Allowance in 2016, investors are less eager to open ISAs to protect their money from the taxman.
The tax break gives basic-rate taxpayers a £1,000 buffer on savings income and a £500 tax break for higher-rate payers, meaning many savers needn’t get an ISA to protect their gains. But as the number of ISAs opened has fallen for the past six years consecutively, thousands of pounds could be lost by those who should be saving through these tax-efficient accounts.
Laura Suter, personal finance analyst at investment platform AJ Bell, comments:
“Many people may not think they need to use ISAs, either because they are not aware of the tax benefits or because they think their current circumstances mean there is no particular benefit - and in reality a minority of people can afford to max out the ISA limit of £20,000.
“However, this ignores the fact that people’s circumstances can change as they accumulate wealth during their life and the Government can tinker with the tax rules, resulting in tax breaks being withdrawn. Once money is inside an ISA it is protected from tax forever, even if that tax advantage is not felt by the investor immediately.
“We’re shining a light on five groups of people who should be using an ISA to avoid being hit with a tax charges in the future or missing out on free Government cash.”
The Income Withdrawer (or Future Income Withdrawer)
“Investors have been hit in recent years by successive changes to the dividend tax allowance, first increasing the tax rate and then slashing the tax-free dividend allowance. Now you can earn just £2,000 in dividends before you start to pay tax, at 7.5% for basic-rate taxpayers, 32.5% for a higher-rate taxpayer or 38.1% for additional-rate taxpayers. The £2,000 allowance means that someone with a £50,000 pot earning a 4% yield will hit the limit. If you moved this money into an ISA then it will be free of income tax.
“This is also important for people who plan to take an income from their ISA savings in future years. Any withdrawals from ISAs are free of tax, meaning you can draw an entirely tax-free income off the investment pot. For someone with £200,000 in an ISA, earning a 4% yield can take a £8,000 income tax free each year, while someone with a £600,000 ISA will be able to take £24,000 income tax free – at this level you’ll save £2,300 each year in tax, assuming you have no other income. If you take this same income over 20 years, for example, that’s a total of £46,000 saved in income tax.”
The Tax-Bracket Leapers
“If you move from the basic-rate tax band to the higher-rate your Personal Savings Allowance will be slashed by £500, meaning only your first £500 of savings income will be tax free. If you jump from the higher rate to the additional rate band you will lose the allowance entirely, meaning all your non-ISA savings interest will be taxed at 45%.
“For example, if you change from the basic to higher-rate tax band you’ll face a £200 tax bill on that £500 of savings interest. If you’re close to these tax band limits and think you might get a pay rise that tips you over in the next tax year it could be a good idea to move some of your money into an ISA.”
The First-Time Homeowner
“For those planning to buy a first property in the future, you should use an ISA to get free Government money. With a Lifetime ISA you get a 25% Government bonus on the money you pay into the account, which will then go towards your first home – a rate of return that’s hard to beat. The Lifetime ISA took over from Help to Buy ISA last year, as the Help to Buy ISA was closed to new account openings in November.
“The Lifetime ISA has a higher annual limit of £4,000, and also a higher Government bonus of £1,000 each year, but it only works if you have at least 12 months until you plan to buy a house. If you opened a Help to Buy ISA before the November deadline, you can keep subscribing up to £200 a month until November 2029 with the 25% Government bonus being added on top.”
The Super-size Gains Investor
“Someone who has held investments outside an ISA for a long time or has seen their investments perform particularly well may well have large capital gains on their investments. For investments outside of an ISA they will pay 10% or 20% tax on any gains above their tax-free allowance, depending on their income tax bracket. You can make use of your capital gains tax allowance each year to bank some gains and move them inside an ISA.
“So-called ‘Bed and ISA’ means you can sell assets with gains of up to £12,000 and then buy them back within an ISA, without facing any tax. Your future gains will then be protected from capital gains tax too. You can do a similar move but transfer the asset to your spouse instead, who can then put it in their ISA.”
The Big Savers
“If you’ve managed to build up a sizeable savings or investment pot – great job. But the larger your non-ISA savings the longer it will take to move it into an ISA. You have a £20,000 allowance each year, so if your pot is much larger than this it could take a long time to move it into the tax-efficient ISA.
“Savers with large non-ISA funds are at the mercy of future Governments changing the tax rules on savings, scrapping the personal savings allowance or even reducing the annual amount you can save into an ISA. People were caught out by this before with the cut to the dividend tax allowance and many were hit with a large tax bill. If it will take several years’ worth of allowances to move you money into an ISA, think about starting before the end of this tax year.”
