ISAs

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9. Practical significance of ISA tax rules

Just because ISAs offer a tax advantage doesn't mean that you will necessarily benefit from it. If your income is such that you pay no tax anyway, there's not much point in taking out an ISA because the tax advantages won't help you.

For people who do pay tax, some thought needs to be given to the type of share or fund which you shelter in an ISA.

1. The Income Argument

   For many people the best type of assets to hold in an ISA used to be those that generated income rather than capital growth. Why?

   • Every individual gets an annual CGT exemption of £10,100 (2009-10) anyway. If your annual gains on all your assets are likely to be below £10,100, you won't be paying any CGT, so putting growth shares or funds in an ISA brings no added advantage. And since 'growth shares' often pay small or zero dividends, there won't be much of an income tax saving either.
   • By contrast, if you put high yielding bonds, or shares that pay strong dividends, in an ISA, you will get the tax benefits. You'll receive the income tax free.

   However, in April 2004 the tax credit on dividends was abolished, so the income is now subject to tax.

2. The Capital Growth Argument

   Even if you don't use your CGT outside an ISA, it may be worth putting growth investments into an ISA, if you're planning on leaving them intact for the truly long term. If you need to sell the assets at a long-distant date in the future, and the asset is held outside an ISA, it's true that you can use your CGT annual allowance to minimise any tax due, but that may not be enough to cover all the gains, especially if the investment has done well and has been held a long time. If it had been held within an ISA, it won't matter how much the investment has grown, it will still be free from CGT (assuming current rules still apply at that time).

   As you approach retirement, you can consolidate your gains and switch out of growth funds, into high yielding equities or bonds. This will generate reliable income and, importantly, it will all be tax free.

1. What is an ISA? 2. Who can take out an ISA? 3. ISA investments: the 'Components' 4. The different kinds of ISA: Maxi, Mini and Tessa-only 5. How many ISAs can you have? 6. How much can you put in an ISA? 7. Maxi or Mini? 8. Tax rules on ISAs 9. Practical significance of ISA tax rules 10. Cash ISAs 11. Stocks & Shares ISAs 12. Choosing an ISA fund 13. Buying an ISA 14. Charges and CAT standards 15. Where to find an IFA 16. Switching ISA investments 17. Transferring shares into an ISA 18. Withdrawing funds from an ISA 19. Conclusion