The recent errors with HMRC’s computer system have brought to light the scale of tax individuals are paying (or not as the case may be). With the coalition Government’s changes to the taxation rules the amount of tax people are paying, be it through income tax, capital gains tax, national insurance, VAT or inheritance tax, is only going to increase.
There are many structures available to assist with tax planning, some of which can be very complex and ultimately carry a high degree of investment risk. One area that is often overlooked, and not fully understood, is the uses and practicalities of an ISA.
ISA Allowances
The June emergency budget confirmed that ISA allowances for eligible individuals is now £10,200 per tax year. This allowance is set to increase on an annual basis by the rise in RPI. Of the allowance up to half, i.e. £5,100, can be invested in a cash ISA with the balance in a investment ISA. You can elect to pay more than £5,100 into an investment ISA if you wish, and up to the full limit, but this would reduce the amount than can be invested into a cash ISA, i.e. if £8,000 is placed in an investment ISA then only £2,200 could be deposited in a cash ISA.
The allowance is per individual and per tax year. Therefore a couple could invest up to £20,400 into ISAs during the current tax year.
ISA Taxation Benefits
ISAs do not offer tax relief on the initial investment, but do provide several ongoing tax benefits. As the fund grows this will be free of tax and any gains realised are not liable to capital gains tax. At present capital gains tax stands at 18% for basic rate taxpayers and 28% for higher rate taxpayers. In addition, any income produced by funds in ISAs, either from interest on cash deposits, interest from bonds or dividends on equities is not liable to any additional income tax. This can be a significant benefit, particularly for those paying higher or the new 50% tax rates.
(the 10% tax credit on dividends cannot be reclaimed by ISAs)
Other Benefits
One of the major advantages of ISAs over other forms of tax efficient saving is flexibility. The funds held within ISAs can be accessed at any time, subject to any restrictions on the investments held, without any tax liability on surrender or transfer. There are no age or accessibility restrictions in place, unlike pensions.
Payments to ISAs can also be made in many forms, from single contributions to regular payments (i.e. monthly quarterly etc) and even on an ad-hoc basis. There is also no compulsion to invest on an ongoing basis though if you do not use the allowance in the tax year it is available it is lost and cannot be carried forward.
Fund Growth
Over a period of time the funds held within ISAs can grow to a significant value. Below is a table of projected values assuming that individuals fully utilise their ongoing ISA allowances and is based on conservative net fund growth of 5% and assumes the ISA allowance increases by 3% on an annual basis.
| Year | Total Premiums Single Person | Value Single Person | Total Premiums Joint Couple | Value Joint Couple |
| One | £10,200 | £10,710 | £20,400 | £21,420 |
| Two | £20,706 | £22,277 | £41,412 | £44,554 |
| Three | £31,527 | £34,753 | £63,054 | £69,506 |
| Five | £54,153 | £62,657 | £108,306 | £125,315 |
| Ten | £116,932 | £152,606 | £233,864 | £305,212 |
| Fifteen | £189,709 | £278,974 | £379,418 | £557,949 |
| Twenty | £274,078 | £453,668 | £548,156 | £907,337 |
This shows that for a couple over twenty years the fund value built up, assuming only a conservative growth figure of 5%, can amount to in excess of £900,000.
Options for the fund
As part of an overall financial or retirement plan, ISA funds can be used to provide an income. As part of the ISA rules, the income produced is free from income tax and does not need to be disclosed on tax returns. Assuming a yield of 4.0% this would provide a tax free income of £43,099 based on a fund value of £907,337. This equates to a gross return of 5.0% for basic rate taxpayers, 6.66% for higher rate tax payers and 8.0% for 50% tax payers. Furthermore the capital sum is still available to receive ad-hoc payments without any liability to capital gains tax and the capital can also be distributed to beneficiaries to aid and assist with inheritance tax planning.
The information provided gives an overview of ISAs and how they can be used to provide excellent taxation benefits, significant flexibility and the ability to receive a tax efficient income and/or capital sum. The only real downside of ISAs is the annual limit on how much can be invested and any unused allowance cannot be carried forward.
For those looking to save more lets consider Qualifying Savings Plans which can also provide significant tax savings.
Qualifying Savings Plans
Qualifying Savings Plans are not new to the investment arena and have been around for many years. However, the recent changes to the taxation landscape combined with developments in this market have seen this type of investment coming back to the fore as an effective way of saving in a tax efficient manner.
Taxation
For anyone earning above £43,875 (2010/11 tax year), assuming entitlement to full personal allowances, income in excess of this will be taxed at 40%. For anyone earning above £100,000 adjusted net income, their personal income tax allowance of £6,475 will be reduced by £1 for every £2 above this limit. Effectively, anyone with taxable income above £112,950 will not have a personal income tax allowance. Finally, for those earning over £150,000 per annum income in excess of this level will be taxed at the new higher rate income tax of 50%.
How can Qualifying Savings Plans help?
Qualifying Savings Plans enable investors to save on a monthly, quarterly or annual basis for ten years. They are suitable for individuals who are higher rate taxpayers or top rate taxpayers and are seeking tax efficient investment returns.
A qualifying savings plan normally invests into UK authorised investment funds (collective investments) held as UK life funds. These funds suffer corporation tax in the hands of the life company. The deemed tax rate is said to be 20% however the actual rate paid may be less due to the way life fund taxation is calculated.
A qualifying investment plan takes advantage of UK life assurance rules which state that if a regular premium policy is in force for at least seven and a half years, and all premiums are paid when due throughout this period, it will not suffer any further taxation.
If these conditions are met, this means that the returns are paid back to the investor without any liability to either income tax or capital gains tax. For higher and top rate taxpayers this provides significant taxation benefits over alternative forms of regular savings.
Additional Benefits
- Plans available from age 18 and above.
- Flexibility in terms of having a wide choice of underling investments tailored to meet your objectives which are consistent to your attitude to risk.
- Additional flexibility to change your risk profile over the term of the plan.
- Provides a death benefit dependent upon age and plan value.
At maturity the option is available to reinvest the capital sum in an alternative manner in order to continue to benefit from a tax efficient investment.