Tax and your portfolio: is an ISA for you?
Tax isn’t always a top priority when it comes to investing, but can make a big difference to your outcomes. By being aware of how your investments may be subject to tax, you can minimise its impact. A stocks and shares ISA is a good start.
IN A FEW WORDS
Tax and investing Capital gains tax Dividend tax Tax allowances Stocks and shares ISA
4 min reading
Many investors spend hours researching investment options but give scant attention to how they might be taxed on them. Your choice of tax shelters can be just as important in generating long-term wealth as your choice of stocks, shares or funds – and it can be a whole lot easier.
Tax can eat into your investments
If you do nothing to shelter your investments, you may end up paying tax on anything you make from them. Above a certain level, you will pay income tax on dividends or interest generated from stocks or bonds and if you grow your capital, you may be subject to capital gains tax.
While you can currently make up to £2,000 a year in dividends, anything over and above that will be charged at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. It’s worth noting that you will have to pay this whether or not you withdraw the dividends. In other words, even if they are reinvested back into your portfolio, you will need to pay tax.
This can have a powerful effect on how your capital grows over time. In fact, reinvesting dividends is one of the most effective ways to build wealth over time. Whilst past performance is not a guide to future performance, research shows that the annual growth from an investment in the FTSE 100 from 1993 to 2018 was 4.1% without reinvesting dividends. This jumped to 7.8% with dividends reinvested. For the MSCI World, the difference was between 5.9% and 8.3%. Investors giving up a portion of their dividends in tax risk missing out on some of this valuable extra growth.
Interest on savings
The same applies for interest, either from a savings account or the coupons from a bond, though the allowances are more generous. You can generate £5,000 each tax year in interest tax-free, but only if you earn less than £17,500 per year. Basic rate taxpayers are entitled to a £1,000 annual allowance while higher rate taxpayers only receive £500 as an allowance. Anything you earn above this is subject to tax at your marginal tax rate (the top rate of tax you pay).
Capital gains tax
You can make gains of £12,300 before capital gains tax applies. Tax will then be payable of 28% on gains from residential property (not your main home) and 20% on all other assets. If you are a lower rate taxpayer you may pay less, depending on your level of income and how much unused allowance you have. You should note that capital gains tax is payable even if you give the asset away – this is considered a "chargeable transfer".
Also, you will have to pay capital gains tax on the sale of a UK property even if you are non-resident, but not on stocks and shares as long as you are non-resident for five years or more.
How an ISA can help
ISAs are a good place to start. Anyone who is a UK resident and over 18 can hold an ISA. You can invest up to £20,000 each tax year and hold a broad range of underlying investments – from collective funds, to individual stocks and shares, to ETFs and bonds
Investments held within an ISA are not subject to capital gains tax or income tax. That means anything you make from your investments, you keep. ISAs can be a cost-effective way to invest with low minimum investment levels.
The real beauty of ISAs is that they can be incredibly flexible, depending on the type. While they are designed as a long-term savings vehicle, you can withdraw money at any time, and with a Flexible ISA if you reinvest it within the same tax year it won’t affect your annual allowance. You can also transfer money from an ISA you have built up in previous tax years to another without it affecting your current annual allowance.
ISAs are particularly useful to build up income investments. All the income generated is tax free, so it can be worth using them to shelter dividend-generating investments where you might otherwise be paying significant amounts of tax.
Tax might not be the most exciting part of investing. However, minimising the amount you pay is straightforward and can make a significant difference to your long-term wealth. Sheltering investments within an ISA wrapper is an easy win.
Introducing the Fineco stocks and shares ISA
The new Fineco stocks and shares ISA is a tax-efficient way to hold a broad range of investments across funds, shares, bonds and ETFs. Charging is simple and transparent with a maximum account fee of 0.25% pa (excluding investment costs) for funds, with costs for shares, ETFs and bonds capped at £3.95 each month.
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