By Amy and Eesha | Edited by Johanna Updated August 2015
This is a guide to getting the cheapest stocks and shares ISA. Every adult has a Ј15,240 allowance for 2015/16 - find out how to take full advantage.
In this guide
This is the first incarnation of this guide. Please suggest any changes or questions in the Investing in a stocks & shares ISA discussion. Thanks to Gavin Haynes from Whitechurch Securities for fact-checking the guide.
Stocks & shares ISAs: Need-to-knows
What is a stocks & shares ISA?
Everyone in the UK over 18 has a Ј15,240 ISA allowance. You can choose to use all of this for a stocks & shares ISA if you want, or you can put some in a cash ISA and the rest in a stocks & shares ISA. You can also choose to put the whole amount into a cash ISA.
The new ISA rules that came into effect in 2014 mean that you can now split the money between stocks & shares ISAs and cash ISAs any way you like.
It may still be called an ISA, but a stocks & shares ISA is very different to a cash ISA, which is simply a savings account you don't pay tax on. With a stocks & shares ISA you're investing. This could be in things such as:
- Corporate and government bonds. You basically lend your money to a company or a government in return for interest (don't confuse these with fixed-term bonds, which are basically savings accounts held for a certain period of time).
- Shares. You invest in individual companies. Owning a share is like owning a brick in a house wall. If the price of the house (company) goes up, so does your brick (share), and vice versa.
- Funds. Most people use funds when investing. These can include bonds, shares, a mixture of the two, or in some cases, cash. Most funds have a specific theme, around which all the investments are based.
What exactly are funds?
The fund's theme could be anything from geography (European, Japanese, emerging markets), industry (green companies, utility firms, industrial businesses), types of investment (shares, corporate bonds, gilts), to the size of the company.
The combination gives you the risk factor. If the fund focuses on "fledgling biotech companies in emerging markets", all the elements involve a high degree of uncertainty. So if it goes well you could be in for massive gains, and if it goes badly, massive losses.
Alternatively, it could be a FTSE 100 tracker, where the fund simply invests in the UK's 100 biggest companies, and therefore is much more mainstream. While there can still be substantial ups and downs, the fluctuations are likely to be smaller.
You can also leave your money as cash in a stocks & shares ISA, but you
typically won't get a great return (often much less than in a cash ISA or savings account).
They're tax-efficient, but not always tax-free
It's very important you understand what the tax breaks are and whether they really matter to you before you decide to use your ISA allowance for investing.
Unlike the clear-cut tax gain of a cash ISA. stocks & shares ISAs help you save some tax, but not all.
A. You don't pay capital gains tax (CGT) on gains made within a ISA - great if you exceed the Ј11,100 annual CGT allowance.
CGT is a tax you'll have to pay on the gain you make when selling things such as shares, a second home (you don’t pay capital gains on selling your first home) and jewellery.
So if you buy shares at Ј1,000 and then sell them for Ј1,500, you’ve made a Ј500 gain. You might then have to pay tax on that. But it’s important to understand that.
You’re allowed to make Ј11,100 of gains this tax year (2015/16) tax-free outside an ISA. So you would ONLY gain using a stocks & shares ISA in a year where you were making total gains over Ј11,1 00.
B. Dividends are taxed at 10% in an ISA - but only higher-rate taxpayers gain.
There are two ways you make money from investing. One is when the shares increase in value and then you reap a nice little profit when you sell them. The other is when they pay dividends.
Dividends are a bit like interest on a savings account. If a company makes a profit, it gives some of it back to you - it could be on a regular basis or as a one-off. And just like interest on savings account, dividends are taxed, at 10%. Outside an ISA, basic-rate taxpayers also pay 10%, while higher-rate taxpayers pay 32.5%. So.
Basic-rate taxpayers don’t get any tax gains on dividends from being in an ISA, only higher-rate taxpayers do.
C. You don't pay any income tax on interest from corporate bonds in an ISA.
With corporate bonds, instead of investing in a company’s success, you’re effectively lending money to it for a set time. In return, it'll have to pay you interest.
You're taking the risk that it won't give you the money back, so it isn't risk-free. But the good news is.
If you've got corporate bonds, or bond funds within an ISA that pays out interest, you don't have to pay any tax on it.
If you're investing in corporate bonds outside a stocks & shares ISA, you'll pay your normal rate of tax. So a basic-rate taxpayer will pay 20% tax, and a higher-rate taxpayer 40%.
Still not sure? It's time for a table on the tax benefits of a stocks & shares ISA.
Will you benefit from using a stocks & shares ISA?