View more on these topics

You can count on the magic numbers of Isas

No financial adviser needs be reminded that an Isa is tax- efficient but because the recession has brought public anxiety about big things such as job security and a general suspicion of financial markets, the importance of using the Isa allowance might be undervalued by the public right now.

The annual Isa allowance is given on a use it or lose it basis so missing out could mean throwing money away at a time when investors should be looking to eke out every penny.

The argument for using it is so strong that even where the client has no new money or simply will not invest more money they should consider maximising this valuable allowance.

Higher-rate taxpayers could double their real return by wrapping their investments in an Isa rather than leaving them outside and exposed to the taxman.

Even where money is already invested elsewhere, they should consider transferring from an existing insurance bond or collective to the shelter of an Isa.

For those getting income from miserly deposit accounts, an Isa will bring in a little extra in the face of falling interest rates. If they are unsure about committing to new investment in the immediate term, the money could be temporarily parked in cash.

In normal years, Isa money has flowed in because even the public knows it makes some sort of tax sense, it is anchored as the first port of call for new investments.

However, what may be questioned is whether they really understand or value just how important this allowance is.

Yes, Isas are accompanied by the term tax-efficient but this is a woolly term. It lacks substance and quantum, it does not really tell me just how stunning the Isa is or what I might be losing in hard cash if I forgo my allowance this year. Our challenge in this extraordinary year is to make an even stronger and proven case for the tax benefits of the Isa in order to draw the client to the inevitable conclusion that they should not let the allowance go. It must be made clear that putting money in an Isa returns more to the investor than using other wrappers.

The case could not be clearer than when made in numbers.

Ignoring for the moment, the capital gains tax allowance and inflation, we can show the additional return to be gained from using an Isa wrapper for any given investments, compared with using collectives and insurance bonds.

Wherever the money is invested, it will produce a return in the form of either interest, dividends, rent or capital growth.

Assuming the Isa manager is able to glean all relevant tax benefits, table 1 shows the additional simple return to be achieved by higher and basic-rate taxpayers from the Isa versus the other wrappers.

Now imagine a particular supermarket offering such discounts when its competitors were not. Shoppers would be scrambling for the shelves, recession notwithstanding. If all else is equal, it would seem almost indefensible not to consider moving assets from an existing wrapper into an Isa. There are a couple of helpful points to consider if the client is switching wrapper.

First, the 5 per cent withdrawal facility of an insurance bond may be useful to fund the Isa. Second, the bed and breakfast rules do not apply to an Isa, which means there is no tax problem in keeping exactly the same funds if moving from an existing collective to Isa.

Having digested the headline additional returns available to Isa savers of different personal tax rates, we must then consider when any tax is paid, as this influences the ultimate total return to an investor. Also, in table 1, we ignore CGT and inflation.

Often, I see it written that there is little point in a basic rate taxpayer doing an equity Isa, because, first, there is no tax advantage in respect of the dividends and second, with the annual CGT allowance at £9,600, growth would need to be spectacular on £7,200. It is true that the tax advantages may not look as good compared with a cash or bond Isa but this is still really short-sighted.

First, the CGT allowance is additional to the Isa allowance, not mutually exclusive, so you can take out the Isa and keep the CGT allow- ance for other investments.

Second, why run the risk of the investor being dependent on the current CGT regime remaining the same until the investment is cashed in? More profoundly, it misses the central concept of building a bigger tax shelter over time. Given that the annual Isa allowance remains capped, you simply cannot invest all your money in one year – it takes time.

Table 2 assumes that the investor has built up an investment of £50,000 and shows the investment growth in the following 10 years after all taxes and assuming neutral charges.

The difference between the wrappers is nothing other than tax, the underlying investments are exactly the same and there is the same underlying gross investment return.

The statistics look impressive and only now does the term tax efficiency take on greater meaning, there is nothing woolly in that table.

If the Isa allowance is not used, the client is simply agreeing to give some of their future returns to the taxman. Not just this year, but the next and the next and so on.

Each year, they throw away their allowance, sacrificing the magic power of compounding.

This year sees us in a recession, a credit crunch and with historically low interest rates. The Isa allowance is unlikely to rank high on the public mind. Our challenge is to save investors from indifference now so they do not lose out in the future.

Table 2 Collective Onshore bond Offshore bond Isa Additional return from Isa over worst

UK fixed-interest fund HRT £17,196 £19,210 £18,867 £31,445 83% (5% pa interest) BRT £24,012 £24,012 £25,156 £31,445 31% UK equity income fund HRT £42,660 £38,686 £31,831 £53,052 67% (3% pa div yield, BRT £49,428 £48,358 £42,441 £53,052 25% 4.5% pa growth, RPI 2%)Table 1

Collective Onshore bond Offshore bond

UK interest HRT 67% higher 56% higher 67% higher BRT 25% higher 25% higher 25% higher

Capital growth HRT 22% higher 56% higher 67% higher BRT 22% higher 25% higher 25% higher

UK dividends HRT 33% higher 25% higher 67% higher BRT 0% higher 0% higher 25% higher

UK rent HRT 67% higher 56% higher 108% higher BRT 25% higher 25% higher 56% higher

Recommended

Midas to waive loan covenants

Aim-listed asset manager Midas Capital has reached an agreement with its bank to waive loan covenants until April 30 with the aim of restructuring its borrowing arrangements.

Global income: preparing for a rate rise…

In the five years since we launched the Artemis Global Income Fund, its manager Jacob de Tusch-Lec has built a distinctive portfolio that is first among its peers. Here he explains why his “quality, cyclical and value yield” stocks, and flexible approach, leave the fund better placed to benefit from uncertainty than funds that depend […]

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

    Leave a comment