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 almost 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. Shares listed on the Alternative Investment Market (AIM) can also be included following a rule change in 2013. However, shares in private companies are not allowed.
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 £11,880, into a stocks and shares ISA. However, from 1 July 2014 the annual ISA allowance will be increased to £15,000 and you will be able to put as much as you like either in cash or stocks and shares, as well as transferring freely from one to the other.
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 amount to 18 per cent or 28 per cent of any gains, depending on your level of income (although the annual CGT exemption of £11,000 makes this benefit rather moot until you have built up a substantial ISA portfolio and want to liquidate a substantial chunk of it).
You also don’t pay any income tax on dividends or interest at your personal rate.
However, equities already pay their dividends with 10 per cent tax taken off (known as 'withholding tax') and there is no recourse for you to reclaim that. If you are a higher or additional rate income tax payer, you will still benefit from receiving your dividends within an ISA because you won't have to pay any extra tax on them, but if you pay tax at the basic rate, there will be no advantage to the ISA wrapper at least as far as dividends are concerned.
That said, 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. Finally, ISAs are not free from inheritance tax: when you die, they are treated as part of your estate.
With these exceptions, investments within stocks and shares ISAs are tax-free. 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 are still regarded as having used up that part of your allowance for the tax year. So, for example, if you invest your full £15,000 in the first six months of the 2014/15 tax year, then withdraw £10,000, you will not be able to replace this until next tax year when your ISA allowance is refreshed.
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 exit fees, usually about £25 for every fund or share you hold. Unlike with cash ISAs, the process can be long-winded and the costs considerable, so 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 this isn't usually the best option as the investment choice can be restricted and the costs uncompetitive. You'd generally be better off opting for a fund supermarket, share dealing service or even going direct to investment providers.
Fund supermarkets such as those provided by Bestinvest, Charles Stanley Direct, Fidelity and Hargreaves Lansdown 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.
Online share dealing services, such as those of Halifax Share Dealing, Interactive Investor, iWeb and TD Direct now also offer access to funds as well as shares. This has brought them into direct competition with fund supermarkets, and sometimes they can offer a cheaper deal depending on how much you have to invest and how much you trade.
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.
Typical costs levied by fund supermarkets and online brokers include:
- dealing fees (for buying or selling investments)
- platform fees (either a regular flat fee, or a percentage fee based on the value of your ISA)
- ISA administration fees (usually a flat annual charge)
- exit fees (when you want to switch to another provider's ISA)
Guide originally published: 23/7/12. Updated: 3/4/14.
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