Profiting From Share ISAs

A share ISA is a tax-proof wrapper that allows you to protect a wide range of investments from the taxman. They were first introduced back in 1999 and initially proved very popular. In their first year 4.5m people took one out, investing a total of £16bn. But their popularity has waned somewhat since then as the stock market has struggled. Last year a mere 3m of us got a share ISA investing a total of £10bn.

In contrast, cash ISAs have boomed over the same period with the numbers of people taking one out and the money investing nearly trebling. But share ISAs are still big business and over the years we’ve sheltered a total of nearly £100bn from the taxman in this way. The tax benefits compound year upon year and they can be used to build a sizable portfolio.

How do share ISAs work?

There is an annual limit for how much you can put into a share ISA. For the current tax year, which runs from April 6 to April 5, it’s £7,200. In previous years it was £7,000. You may not be able to put in the full amount if you also get a cash ISA. The maximum you can put into a cash ISA this year is £3,600 so you could out £3,600 into a share ISA and £3,600 into a cash ISA. Alternatively you could put, say, £2,000 into a cash ISA and £5,200 into a share ISA.

You have to open a share ISA with a cheque or bank transfer and this money is then used to purchase the investments you want. You can transfer existing investments you have into an ISA but they first have to be sold and the money from the sale can then be used to buy back the investments within the ISA. This incurs some costs but some brokers will waive some of their fees if you decide to go down this route.

Any income you earn from your investments in an ISA is free of tax. This isn’t quite as useful as it sounds as, generally speaking, only higher-rate taxpayers pay additional tax on dividends they receive from share investments.

The real tax benefit comes from paying no capital gains tax. This tax is charged at 18% on any profit you make although you have an annual exemption amount, which is £9,600 for the 2008/09 tax year. While you may think you won’t ever make a profit of this amount, your gains can soon mount up once you’ve invested in ISAs for several years. Be aware though, that once you take any investment outside of its ISA wrapper it will become subject to the ravages of tax once more.

One disadvantage of share ISAs is that any losses you make on investments you sell can’t be used to offset against profits you make elsewhere. However, this problem only really affects those people who have substantial investment portfolios.

You can put all sorts of investments into a share ISA. Most people put in investment funds such as unit trusts, open ended investment companies (effectively an updated version of a unit trust) and exchange traded funds but you can also invest in gilts (loans to the UK government) and corporate bonds (loans to large companies). You can’t buy property within a share ISA although you can buy funds that invest in property or shares in property companies.

Many fund companies have set up regular investment schemes whereby you can put in as little as £25 a month. You can also put in one-off lump sum investments, typically starting at £500 and then £250 thereafter. These are good ways to get started in investing.

You can buy individual shares with a share ISA too of course, both of UK companies and those that based abroad. The stipulation here is that the share has to be traded on what is known as a recognised stock exchange such as London or New York. Many smaller companies in the UK trade on a junior market called AIM however this is not classified as a recognised stock exchange so, generally speaking, these companies can’t be put into an ISA. This may all sound a bit complicated but the broker who runs your ISA will be able to tell you what companies you can invest in within an ISA if you are in any doubt.

Most share ISAs are free so you don’t have to pay anything to protect your investments from tax. One exception tends to be share ISAs run by brokers that let you buy individual shares, often known as self-select ISAs. These often have a small annual charge of around £25 to £50.

What about PEPs?

PEPs, or Personal Equity Plans, were tax-free investment schemes that preceded ISAs. You could put money into PEPs from 1987 to 1999. The annual subscription limit in the last year they were available was £9,000, quite a bit higher than the current limit for share ISAs.

As of 6 April 2008, any investments still held in PEPs (reckoned to be around £80bn) are now classified as share ISAs. Previously the two were kept separate but now you can combine all your tax-free investment in one single ISA wrapper.

An alternative to pensions?

ISAs are often seen as an alternative to pensions when it comes to saving for retirement. Both give you an element of tax relief but in a different fashion. Pensions probably have the edge in this respect although it will depend on your individual tax situation. The annual investment limits for pensions are substantially higher however (in excess of £200,000).

ISAs are considerably more flexible than pensions. You can get at your money whenever you like and you don’t need to convert your money into an annuity before the age of 75 as you currently have to do with a pension.

As both pensions and ISAs have their advantages many people put money into both each year as a means of saving for their retirement. If you have enough funds to do so, this is usually an excellent idea!