Individual savings accounts (ISAs) can sound a bit complicated to the uninitiated. And it probably doesn’t help that there are several ISA versions, each with varying characteristics that appeal to different types of savers and investors.
Take stocks and shares ISAs, for example. Here’s a look at what they are, how they work, plus tips on how to pick the best one for you.
What is an ISA?
The first thing to remember about ISAs is that they are a type of government-backed financial wrapper that provides a tax-free way to save and invest.
Saving and investing tax-free is a good thing to do. The less tax you’re legally obliged to pay on your savings and investments, the more of your money stays in your pocket.
Every adult in the UK is given an annual ISA allowance, which is £20,000 for the current 2021/22 tax year. This is the maximum amount you can put in your ISA pot for the tax year that started on 6 April 2021.
Many savers prefer the security of keeping their money in ‘cash ISAs’ - effectively tax-free savings accounts.
While cash ISAs are ultra-safe, with the interest rates they pay hovering between 0.5% and 2%, their returns are nothing to write home about. Especially when you consider that inflation, which reduces the spending power of savings, is currently running well above 5%.
Investors who are on the hunt for a superior return to cash may be able to achieve this by allocating some, or all, of their ISA allowance to the stock market via a stocks and shares ISA.
Note that stock market investing should be viewed as a long-term play (five years absolute minimum, preferably far longer) and, even then, it’s not for everyone. There are no guarantees and it’s possible to lose money opting for this route.
What is a stocks and shares ISA?
Stocks and shares ISAs allow their holders to gain exposure to the stock market in a variety of tax-efficient ways .
These include by directly investing in company shares and also by investing in managed funds which themselves invest in financial markets.
These funds, including unit trusts and investment trusts, are run by professional managers who pool the savings of like-minded retail investors who share the gains or losses. Funds provide exposure to a variety of asset types, including shares (both domestic and overseas), government and corporate bonds, and property.
Stocks and shares ISAs also provide investors with the chance to gain exposure to more eclectic assets such as fine wine and land. But the vast majority stick with shares and bonds.
Note that you can only open one stocks and shares ISA each year. If you end up with several running at the same time, you’re only allowed to pay into one of these during any tax year.
What are the benefits of a stocks and shares ISA?
Stocks and shares ISAs shelter any returns your investments make from three key areas of tax, namely, income tax, dividend tax and capital gains tax.
Take income tax. It affects more than just your take-home pay. It’s also a tax that’s levied on the interest produced by certain types of investments, including bonds and some funds. Any interest-bearing investments such as these held in a stocks and shares ISA, however, are not liable to income tax.
Turning to share dividends, these are income payments made to investors based on the profits that have been generated by a particular company. Companies are not obliged to pay dividends - and many don’t.
But for those that do, investors are given an allowance of £2,000 for the 2021/22 tax year before having to pay tax.
Once that limit has been reached, the rate is then applied at 7.5% for basic rate taxpayers, and 32.5% and 38.1% respectively for higher and additional rate taxpayers.
However, the obligation to pay tax on dividends disappears altogether when investments are held in stocks and shares ISAs.
Capital gains
You’re also obliged to pay Capital Gains Tax (CGT) when you make a gain from selling assets such as shares, a second property (although it doesn’t apply on your main home), and other tangible items such as jewellery.
Everyone has an annual CGT allowance which currently stands at £12,300 for the 2021/22 tax year. If you hold investments such as shares outside an ISA, you’ll pay tax on any gains you make above this threshold. The rate is 10% for basic rate taxpayers and 20% for higher/additional rate taxpayers.
Any gains made by investments held within a stocks and shares ISA, however, are not subject to CGT.
Another benefit of stocks and shares ISAs is that, should you need to fill in a tax return, there is no need to declare profits on it. In fact, you don’t need to mention the fact that you have any ISAs at all.
How do I open a stocks and shares ISA?
Stocks and shares ISAs can be opened direct from a range of financial services companies including banks, investment firms and stockbrokers.
An alternative way to start an account is by using an online investment platform or fund supermarket. In recent years, this option has become the preferred route for most retail investors.
How do I choose a platform?
The UK’s investment platform market is highly competitive with dozens of providers offering access to stocks and shares ISAs. These include the likes of Hargreaves Lansdown, interactive investor, Vanguard, Halifax and AJ Bell.
Platforms offer a range of services from basic to expensive premium-range options. Finding the best stocks and shares ISA provider for your particular needs depends on a number of factors. These include how familiar you are with investing, how you want to invest, and the sort of service you’re looking for.
For example, experienced investors may require no more than a basic service that enables them to buy and sell investments and view their account online.
By contrast, if you’re new to investing, you may want the option of having as much information to hand as possible - including online tools that can help inform your decisions.
With inexperienced investors in mind, several providers have created ready-made portfolios featuring a range of relevant investments based on attitudes towards risk.
What does it cost?
Whether you’re a veteran investor or new to stock market trading, it pays to remember that it always costs money to invest and that fees will be charged to your stocks and shares ISA regardless of how your investments perform.
Charges are applied to a variety of transactions and will vary according to the make-up of your investment portfolio. For example, whether you decide to hold company shares or a range of funds. Your trading style (frequent, occasional, etc) will play a part in dictating fees as well.
Platform charges
Almost all platform providers will charge a version of some kind of servicing fee. This might be applied as a flat fee levied monthly. Or it could be an amount that’s calculated annually (and capped at a maximum amount) based on a percentage of the money you hold on the service.
Flat fees tend to work out as better value if you’re likely to invest a lot of money, compared with the same charge that’s applied to a smaller sum held within your ISA. Percentage-based charges, while attractive to start with, become increasingly more costly as the amount that gets invested rises.
Admin and dealing costs
On top of platform costs, funds held within a stocks and shares ISA will also be subject to an annual management fee from the provider offering the fund itself - an investment management firm, for example. This can range from between 0.1% and 1% of the relevant holding.
Platforms are also likely to apply a dealing charge every time you buy or dispose of a share or fund that’s held within your ISA wrapper.
Most platforms will charge either a fixed fee per trade (which itself may alter depending on the frequency of your trades), or it will be calculated as a percentage of the investment that you’re making.
If you’re planning on doing a lot of share trading, look for platforms that allow a certain number of free trades per month. Some trading apps – basically a type of platform you can access from your smartphone or wallet – offer the option of commission-free trades on stocks.
Apps offset these costs by making money in other ways. For example, by charging currency conversion fees for trades made on companies found on overseas stock exchanges.
Transfer fees
When it comes to charges, make a note that while providers are happy to transfer investments into your account for free, customers are often saddled with an exit fee should they decide to move their holdings to a rival provider.
Bear in mind as well that inactivity fees may apply where an investor let his or her account lie dormant for long periods at a time (12 months, say). To avoid being stung for fees needlessly, check before signing up, if this sounds like your potential trading style.
If you prefer to carry out your trades by phone rather than online, check also that this option exists and what it costs before committing to a particular platform provider.
Other considerations
Keeping charges to a minimum is an important facet of investing for all traders. But there are other aspects to watch out for as well when choosing a provider. These include ease of access to your account, customer service levels (look for phone-based options available 24/7) and consumer protection.
When it comes to protecting your cash, check that your stocks and shares ISA provider is covered by the Financial Services Compensation Scheme.
If your provider should go bust, it means that up to £85,000 of your investments are protected. Note that this doesn’t include any losses that arise from poor investment decisions on your part. It just covers the eventuality should the company that’s overseeing your investments go out of business.
