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Sarah Bradford outlines the tax benefits and limits for Individual Savings Accounts (ISAs)

Introduction

Savers have been hit hard by low interest rates, which in many cases have resulted in a dramatic drop in income. It therefore makes sense to ensure that any savings income is not further eroded by tax paid unnecessarily. Although as a general rule savings income is taxable, tax-free savings and investment opportunities do exist.

Arguably the most well-known vehicle for tax-free savings is the Individual Savings Account (ISA). ISAs have been around since 1999 and can be used to save cash or to invest in stocks and shares.

What Can Be Invested in an ISA?

The amount that can be invested in an ISA is subject to a limit for each tax year. For 2010/11 the overall limit is £10,200 of which up £5,100 (50% of the overall limit) can be invested in a cash ISA, with the balance in stocks and shares. 

From 6 April 2011, the overall limit increases to £10,680 of which up to £5,340 can be invested in a cash ISA, again with the balance in stocks and shares. There is no requirement to have a cash ISA and if preferred the whole limit can be invested in stocks and shares. Likewise, a saver can invest only in a cash ISA, subject of course to the cash ISA investment limit.

The limits apply for each tax year and any unused amount is lost at the end of the tax year. There is no carry-forward facility.

What About Tax?

Interest paid on cash invested in a cash ISA is tax-free and does not need to be declared on the Self-Assessment tax return. Likewise, where shares or funds are invested in an ISA, capital growth is free of Capital Gains Tax (CGT) and there is no tax to pay on any dividends received on ISA investments.

Examples

1. Henry invests in a cash-only ISA. He can invest up to £5,100 in 2010/11 and up to £5,340 in 2011/12. Interest paid is tax-free.
2. Ruby wants to invest in both a stocks and shares and a cash ISA. She has £4,000 to invest in a cash ISA in 2010/11. She can invest up to £6,200 in a stocks and shares ISA.

Savers wishing to maximise the opportunities for tax-free investment should make the most of the limits. Where the maximum investment for 2010/11 has not already been made, savers have until 5 April 2011 to make further investments up to the limit.

New limits apply from 6 April 2011 for the 2011/12 tax year and the full amount for the year can be invested on 6 April 2011 to maximise the opportunity for tax-free returns.

The tax saved will depend on the taxpayer’s marginal rate of tax and whether income is received in the form of interest or dividends. For example, a 40% taxpayer would save tax of 40% on any interest received and 32.5% on any dividend income. These are savings worth having.

Practical Tip

The opportunity to invest in an ISA is open to anyone who is UK resident, 16 or over as regards a cash ISA or 18 or over as regards a stocks and shares ISA. This is an opportunity that should not be overlooked.

Budget 2011 Update

The above article was published before the Budget on 23 March 2011, when, the following announcements were made concerning ISAs:

1) Introduction of Junior ISAs - A new junior ISA will be available for UK resident children (under 18s) who do not have a Child Trust Fund (CTF) account. Junior ISAs will be tax-relieved and will have many features in common with existing ISA products. They will be available as a cash or stocks and shares product. It is expected that Junior ISAs will be available from Autumn 2011.

2) ISA subscription limit - The annual ISA subscription limit will be increased annually by reference to the Consumer Prices Index (CPI) from the 2012/13 tax year, instead of the Retail Prices Index (RPI). The CPI for September in the preceding year will be used and the increased limit will be rounded to £120 to allow for regular monthly payments to be made. If the CPI is negative the limit will be unchanged. Following indexation the cash ISA limit will continue to be half the value of the stocks and shares ISA limit. The limit for 2011/12 is increased from £10,200 to £10,680, of which £5,340 may be saved in a stocks and shares ISA.