New rules for taxing dividends and allowing payment of ordinary bank deposit interest tax-free will fundamentally change what assets savers and investors hold in different wrappers.
From 6 April, the new tax rules for bank deposits will see banks pay interest gross, rather than after a deduction of 20 per cent income tax.
Under a new personal savings allowance, the first £1,000 of interest will be tax-free for basic rate taxpayers and the first £500 for higher rate taxpayers. Additional rate taxpayers will receive no allowance. Non-taxpayers will no longer need to fill out the R85 form to receive interest without tax deducted.
Even at an interest rate of 1.5 per cent, basic rate taxpayers will be able to shelter nearly £70,000 in an ordinary bank deposit account and higher rate taxpayers will be able to shelter £30,000. This effectively creates another Isa-like home for cash savings.
This means that Isa allowances can be left free for other assets. Another change, allowing Isas to be replenished in the same tax year, also takes effect from April. This will allow investors to move cash currently within their Isas into normal bank deposit accounts in order to benefit from the new personal savings allowance.
They can then restock their Isa within the same tax year with other assets, such as non-Isa Oeics and unit trusts, up to the amount they had in their Isa before taking cash out, without using up their annual Isa allowance of £15,240.
Meanwhile, the new dividend tax rules will change the basis of taxing dividends from direct shareholdings and from collectives such as Oeics and unit trusts. The first £5,000 of dividend income is received tax-free for both basic rate and higher rate income taxpayers. At the end of 2015, the dividend yield on the FTSE All Share was 3.7 per cent. Up to £135,000 of shares in limited companies or collective funds with a similar yield can therefore be held outside of an Isa or pension without incurring income tax on the dividend.
This rule change could see investors move equity income assets outside of pension and Isa wrappers to use this new £5,000 allowance. By targeting equity income stocks and collectives, capital growth is potentially covered by the exempt amount for capital gains. If so, this creates another Isa-like home for a substantial amount of share-based investments.
That leaves Isas free to hold growth-oriented assets and to receive interest and dividend income that cannot be covered by the new personal savings and dividend allowances. Using these allowances to their fullest alongside Isas and pensions should mean the vast majority of UK savers and investors pay no tax on their savings and investments, except for taxable withdrawals from pensions (which should be more than compensated by tax relief and tax-free cash).
In addition to the ongoing needs created by the new flexible pension rules, these changes once again allow advisers to demonstrate their worth to clients in terms of hard cash saved by aligning savings and investments with the most appropriate wrapper or allowance.
John Lawson is head of financial research at Aviva