Decision time, Cash or Investment ISA?
ISA season is almost upon us and so the time has come when thousands of UK people will be thinking about how to prevent the taxman taking a hefty chunk out of their savings.
Designed to be a way to enable savers to earn high rates of interest without having to pay any tax, ISAs have been a popular way to save over the years.
However, with the allowance struggling to keep up with inflation and interest rates painting a bleak picture, many will be wondering whether it’s worth all the hassle.
Well, don’t give it up just yet as there does seem to be a glimmer of hope for these tax-free accounts. People are ploughing more cash back into ISAs – up by over £1,000 on average between 2012 and 2013.
If you’re thinking about taking your chances with an ISA before the end of the tax year, which type will you go for: cash or shares?
What’s the difference?
There are two types of ISA (individual savings account): a cash ISA and a stocks & shares ISA. Despite both offering tax-free benefits, there are some significant differences between the two.
First off, you will need to consider your attitude towards investment risk. With a cash ISA there is no risk – it is simply a standard savings account in a tax free wrapper.
On the other hand, a stocks & shares ISA puts your cash into various funds, trusts, bonds and shares. This means that there is a possibility that the value of your ISA will go down, as well as up.
What is the limit?
As ISAs offer tax-free savings and investments, there is a limit as to how much you can save. For the 2013/14 tax year the ISA allowance is £11,520 – up to half of which can be cash.
So, if you only have a Cash ISA, you can only deposit a maximum of £5,760, whereas if you have stocks & shares ISA investment you can invest the entire £11,520. If you wish to mix and match, you can put up to £5,760 in each.
The ISA allowance is due to increase for the 2014/15 tax year to £11,880, but the same rules apply, so the cash ISA limit will be £5,940.
Don’t forget, the allowance is the amount deposited into the account. If you deposit £5,760, then withdraw it, you will lose all tax free benefits and won’t be able to put any money back into the account until the next tax year.
It’s also worth remembering that any unused allowance does not roll over, so if you don’t use it, you lose it.
Fixed rate or a risk?
Choosing between a cash and shares ISA isn’t as simply as you might think. While a part of that decision will depend on your attitude to investment risk, the most important part should be decided on whether you stand to gain by investing.
A standard Cash ISA is simple, it’s essentially a savings account where you don’t have to pay income tax (which you probably already pay on your salary) on interest. You can easily compare interest rates here and other features to find the most suitable account.
With a stocks & shares ISA, your investments are exempt from capital gains tax – an entirely different kettle of fish.
You are able to earn as much as £10,900 a year in interest before you’re expected to pay this tax. Therefore, the tax free benefits may not even apply to you.
On the other hand, if you are a CGT payer and expect to hit the threshold, an ISA could help cut your costs. Dividend income is taxed at 10%, 32.5% and 37.5%, for basic, higher and additional rate taxpayers respectively. However, in an ISA the maximum rate is 10% – a large saving for big investors.
Rates for top deals
Unfortunately, returns on all savings accounts – including ISAs – have been hit by the low Bank of England base rate. Just last year, it was reported that the average AER on a Cash ISA with a balance of £3,000 was 1.74%.
However, if you spend a bit of time searching, you’ll still be able to benefit from a better-than-average interest rate.
In terms of stocks & shares ISAs you will want to look at the ‘crown rating’ as supplied by the Financial Express. This is indicative of its past performance and along with the fund risk should guide your decision.
Liontrust Special Situations is currently one of the market leaders, with a crown rating of five, 0% initial charge, 1.75% annual charge and medium to high fund risk.
|Written by :|
|Jemma is a news & research reporter for compareandsave.com.Having worked as a journalist on a number of personal finance websites; she now spends time researching and commenting on UK personal finance stories and investigating new ways to help our readers save money.For press enquiries, please visit our Media Centre page.|