ISAs - Not all tax benefits are equal…

While ISAs are well known for being ‘tax-efficient’, your choice of investments can make a big difference to how beneficial they are for you. Whilst all the income and growth you receive from your ISA is tax-free in your hand, how each asset class is treated whilst it remains invested is different – and this can be confusing.

Cash ISAs for instance, are entirely free of income tax. Therefore, if you earn £1 in interest, you receive the whole lot. On a normal bank account, basic rate taxpayers currently pay tax of 20p on that £1 and higher rate taxpayers would be liable for another 20p. Therefore you receive more income from this account than you would do outside an ISA. However, cash ISAs make no capital gain and therefore if you are making profits on investments across your non-ISA portfolio, a cash ISA will be of no help in reducing the Capital Gains Tax burden on that aspect.

Similarly to cash, the interest on corporate bonds is also tax-free. The tax that is paid by companies distributing interest to bond holders is reclaimed on your behalf by your ISA provider and invested into your corporate bond fund to increase the number of units or shares you hold. Unlike cash ISAs, the capital value can fluctuate, and there is therefore the possibility of a tax-free capital gain as well as tax-free income. Of course, on the flip side, that also means there is the chance of a capital loss if markets move against the investment – and also a risk to your income if a company defaults. As a result, corporate bonds generally pay a higher

income than deposits as a way of compensating investors for taking on this additional risk.

The tax benefits on stocks and shares, however, are a little different. Under normal circumstances, basic rate taxpayers currently suffer a 10% tax on dividend income. This 10% tax payment is not refundable within an ISA, regardless of the tax position of the investor. You could argue, therefore, that a stocks and shares ISA offers little additional benefit to a normal basic rate taxpayer. Capital gains within an ISA are tax free, but remember that individuals have an annual gains exemption of £10,600 in any event.

Inheritance Tax Exemptions

Gifts of £3,000 or less are allowed annually without being liable for IHT - and if unused, this allowance can be carried forward for one year. Any number of ‘small’ gifts of £250 or less can be made. There is also a gift exemption applying to ‘regular gifts out of income’. These gifts can be as much as you like, but they must form part of a ‘pattern of giving’ and HMRC must be satisfied that after the gift has been made, you are left with sufficient income to maintain your standard of living. You are also allowed gifts on consideration of marriage or civil partnership. The amounts vary according to your relationship to the bride and groom - at the moment, £5,000 is allowed from the parents, £2,500 from the grandparents and £1,000 by anyone else. Gifts to charities also fall outside inheritance tax.

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