Don’t be an April Financial Fool
The 1st of April is traditionally thought of as April Fools day. But in the financial services industry we tend to think of the 5th of April as being the day that people can be the most foolish. It is of course, the end of the tax year, and at this time every year we see the same thing, which is people throwing away free money that the government wants to give you.
Ok, so that’s not strictly true. But it is true that a portion of your money that you usually grudgingly see handed over to Her Majesty’s Revenue and Customs can be kept completely yours, in the bank, through an ISA.
When you save money as cash in a bank account, or perhaps through an investment fund or share portfolio, most people pay tax on it twice. Once in income tax before they start saving, and then again on the interest gained from the savings, and capital gains tax on the investment profits. Putting that saved money into an Individual Savings Account (ISA) protects it from that second tax hit, and does not need to be reported on a personal tax return.
So how does an ISA work, and why is this time of year important for people with one, (or indeed without one)?
There are two types of ISA, a cash ISA and a Stocks and Shares ISA. You can save in these two different types in any one tax year within limits. You can save up to £10,200 in each tax year, with the full amount in a stocks and shares ISA with one provider, or up to £5,100 can be saved in a cash ISA with the remaining being saved in a stocks and shares ISA with either the same, or another provider.
Imagine the ISA as a bubble. While it is in that bubble it is exempt from tax. A cash ISA is a passive investment, like a normal savings account. Cash ISA providers pay interest on the amount paid in to the bubble. Rates have been low in the past few years, as the Bank of England have kept the base rate historically low. In the past month the average interest rate on individual savings accounts has now risen to 2.27%, the highest since January 2009, partly as a result of banks competing to attract savers as the end of the tax year approaches. However, with inflation hovering between 3.4% and 3.7% over the last few months, despite the low risk associated with simple cash accounts, many savers feel like they aren’t making the most of their money, with inflation quickly eroding the value of their savings.
So what about the Stocks and Shares ISA? They are eligible for the full £10,200 investment over a tax year, a year which is soon approaching deadline. A stocks and shares ISA allows you to put money into a wide range of investments without having to pay tax on the profits that you make. These range from unit trusts to exchange trade funds, bonds and even individual shares. So you get all the benefit of picking and choosing a wide range of company shares or sectors, all within the tax free bubble that an ISA offers.
I’m sure you have all read our previous articles on investing, and therefore are either already buying stocks and shares, or looking to begin, or are simply just interested in the subject.
Historically, over the long term equities have outperformed cash, bonds and most savings accounts, so the ability to get involved in the stock market in a tax efficient way, and profit from any share price gains. Of course, like any stock investment, your portfolio could just as easily incur losses.
Once you have your money in a stocks and shares ISA there are no restrictions on changing your investments within it, outside of normal dealing costs you would incur. Although once you are invested in a stocks and shares ISA you cannot move it into a cash ISA (although you can do this in reverse).
All the usual risks apply to investing in shares through an ISA as they do outside of one. Provided you are happy to take the risk of investing in funds, shares or bonds, a stocks and shares ISA can offer substantial tax benefits in the long term. For your own personal circumstances it is worth speaking to an independent financial or tax adviser before you invest.
ISAs can be a good way of saving for retirement, of for university fees for the kids, or even just a new car. Using up your allowance each year would build a significant portfolio. Make sure within the ISA you diversify, invest in different sectors and even different asset classes – as well as company shares, you can invest in bonds, commodities such as gold and commercial property. Diversification is a crucial method of spreading the risk that is in stocks and shares.
But crucially, time is of the essence. It is approaching the 5th of April, which means the deadline for this tax year’s ISA limit. So if you were going to save the money anyway, shop around for the best ISA deal and don’t be an April Financial Fool by paying more tax than you need to.