Stocks and shares ISAs: the facts

Money in a stocks and shares ISA has the potential to grow considerably while remaining free of tax. What Investment’s guide explains how to take advantage.

Stocks and shares ISAs are confusingly named, given that they can hold any investment except cash. As well as shares in quoted companies, stocks and shares ISAs can also contain:

• Corporate bonds issued by companies on any recognised stock exchange
• Bonds issued by UK or EU governments
• Shares in investment trusts
• Units in unit trusts/OEICs
• Exchange-traded funds (ETFs)
• Shares transferred from an HMRC-approved share option scheme
• Unit- or investment-linked life insurance policies
• And more (full list here)

When it comes to shares, you are only allowed to invest in companies that are listed on what is known as a recognised stock exchange. This includes most major stock exchanges in the world, such as the London Stock Exchange, but does not include the Alternative Investment Market (AIM). Although it has often been argued AIM shares should be eligible, the Treasury has so far resisted lobbying for their inclusion.

While you are only allowed to put half of your yearly ISA allowance in cash, you can put your entire limit, up to the current maximum of £11,280, into a stocks and shares ISA. The government wants to encourage you to invest rather than hold cash because it is better for the economy (if not necessarily for you if the markets are plummeting).

Tax status of stocks and shares ISAs

One important thing to note is that stocks and shares ISAs are not totally tax-free. You don’t have to pay capital gains tax (CGT), which would stand at 18 per cent or 28 per cent, depending on your income (although the annual CGT exemption of £10,600 makes this benefit rather moot in your first year of ISA investing).

You also don’t pay any income tax on dividends or interest at your personal rate, no matter whether that is 20 per cent, 40 per cent or 50 per cent.

However, equities already pay their dividends with 10 per cent tax taken off and there is no recourse for you to reclaim that. However, the yield you get from fixed income (bonds) and other investments is paid as interest and doesn’t incur this tax.

You also cannot avoid the 0.5 per cent stamp duty that is levied on all share or fund purchases. However, other than that, the investments are tax-free and there is no need to declare them to the taxman.

As with a cash ISA, you take your money out of a stocks and shares ISA whenever you want, although, if you do so, you won’t be able to replace the money taken out within the same tax year if you have already used up your maximum allowance.

Switching your ISAs to a different manager, as with a cash ISA, must be done by asking your current provider to transfer it to the new manager because you can’t do it yourself. They cannot refuse to transfer, but they might levy a switching charge or force you to sell all of your investments so that you only transfer cash. Remember to check with your prospective manager what the switching costs are before signing up.

Providers of stocks and shares ISAs

While cash ISAs are offered by all good banks and building societies, stocks and shares ISAs are available from a wider range of providers. You can still invest through your bank, but you can also opt for an online fund platform, fund supermarket, share dealing service or even go direct to investment providers.

Fund platforms, of which Hargreaves Lansdown’s Vantage platform is one of the most popular, provide easy access to a cornucopia of different investments within the same wrapper. This is useful because you are only allowed to open one stocks and shares ISA per year.

These ‘self-select’ ISAs offer a broader choice of investments than some providers that will only offer their own products for investment. The number of different investments you can hold within a self-select ISA is constrained only by the ISA allowance and the minimum investment levels of whatever you are investing in. Most platforms will also allow you to keep your money in cash for a limited amount of time if you want to wait for a better investment opportunity.

Make sure you check the fees your ISA manager will charge you before investing. Costs can stack up and the manager will not always volunteer all this information unasked. Shop around as much as you can for the best deal but remember, if it looks too good to be true, it probably is.

Related investment guides:

Building an ISA portfolio – what to put in your ISA

ISAs – understand the basics of ISA investing

Cash ISAs – a tax-free home for your long-term savings or emergency money

Bonds – a guide to government bonds, corporate bonds and bond funds

Related topics: Diversification, Equities, Investment trusts, ISAs, Open-ended funds, Tax efficient