Creating Income Funds with ISA/PEPs

dazman_3

Hi,

I'm helping my parents to slowly reorganize their finances for a more empowered future retirement. Outside the pensions, we have moved all the money away from the commission insurance type products into trackers and I've even got them started on a High Yield share Portfolio - good start and they are very happy with the performance and transparency.

I'd now like to encourage them to move some of their previous ISA savings into HYP type investments so there is an income stream built up. Being a UK non-resident however I know nothing with regards to doing this in a tax efficient manner. Sorry if this is a dumb question, but can you transfer your previous multiple years of savings to a share wrapper ISA and still have tax protection on any capital gain? If so, does this have to be with the same provider, or can you move to a new one?

If this can be setup and they now have a HYP in a ISA, if they then reinvest dividends, is this tax free or not in the ISA? If they chose to use the dividends as income I presume at that stage it definitely becomes taxable as income on their tax return.

cheerfulcat

dazman wrote:

can you transfer your previous multiple years of savings to a share wrapper ISA and still have tax protection on any capital gain? If so, does this have to be with the same provider, or can you move to a new one?

If this can be setup and they now have a HYP in a ISA, if they then reinvest dividends, is this tax free or not in the ISA? If they chose to use the dividends as income I presume at that stage it definitely becomes taxable as income on their tax return.

If they are cash ISAs then they can't be transferred to stocks and shares ISAs. But if they are S&S ISAs then yes, they can be moved to self-select ISAs with a broker and a HYP set up within the ISA.

There is no longer an advantage to the basic rate taxpayer in the tax treatment of dividends within an ISA ( you used to be able to reclaim a 10% tax credit ) but a higher rate payer saves the extra tax on the dividend. Any income taken from an ISA is tax free, for now ( ISAs are only guaranteed to exist until 2010 ). Nothing to do with the ISA needs to be reported to the taxman.

HTH

Cheerfulcat

dunstonh

You should also be wary of putting the whole portfolio into HYP. Whilst that is flavour of the month currently and has done well in the last 5 years, if you look at periods before that, it has done less well. In the 90s, growth portfolios provided more than income, in the 2000s, it's been the other way round. What is going to happen next?

We don't know. One thing we do know is that things change and different sectors take their turns. If you do want to stick with higher yielding shares/funds, then you could look into include overseas income funds in addition to the UK.

10 years ago (or just over now as the research is getting onto a year old now), had you invested in the top performing fund/sector at that time you would now have less than had you invested in a spread of asset classes and only ended up in the average performing fund in each sector.

Don't put all your eggs (or your parents) into one basket. Especially the area that is currently fashionable.

EdInvestor

dazman wrote:

If this can be setup and they now have a HYP in a ISA, if they then reinvest dividends, is this tax free or not in the ISA? If they chose to use the dividends as income I presume at that stage it definitely becomes taxable as income on their tax return.

Yes, everything generated within an ISA (dividends, interest) is tax free. Everything coming out of an ISA, whether income or capital is tax free.

If your parents are basic rate taxpayers, you may likt to consider using the ISA allowance for commercial property funds/trusts, which were formerly not eligible for tax free status.Such funds fit well IMHO with an HYP, being fairly low risk and offering a generous yield in the 5-6% range.Commercial property as an asset class is not correlated with equities and therefore serves to reduce risk in the type of overall portfolio you describe.

dazman_3

Thanks for all the replies. I'm pretty surprised that once someone has saved in cash, they are restricted to it remaining in cash for tax-free treatment on capital gain! Then again at 4 to 5% gain maybe the benefits are borderline v's getting it into something with the potential to grow faster (i.e a close and recycle into new s&s ISA with current years allowance).

Indeed even myself I'd love to still invest in offshore funds. I invested in a number of great performing funds (HSBC Chinese Equity in particular) and thought I was making up to 44% in this financial year. Only when realized the provider, a well know insurance company, had been chipping away at the equity each year for bizarre things like ‘establishment charges’ on top of back end 5% charges on each fund and 5% up front bid/offer spread did it occur to me that the charge drag is too much to make people wealthy. I got out with my shirt, thanks to favourable dollar/GBP exchange rate supplying thousands on 'surrender' charges but those days are gone! I also learnt why Insurance companies are so profitable high yielders, so I bought some shares in them !

Good also to know that dividend income on ISA does not have to be reported to the taxman - people doing this for a good few years must have managed to make a decent tax free side income on higher yielding shares/income funds!

Invaluable - Thanks,

Daz

Pal

cheerfulcat wrote:

There is no longer an advantage to the basic rate taxpayer in the tax treatment of dividends within an ISA ( you used to be able to reclaim a 10% tax credit ) but a higher rate payer saves the extra tax on the dividend.

EdInvestor wrote:

Yes, everything generated within an ISA (dividends, interest) is tax free.

EdInvestor

Put it this way then:


Basic rate taxpayers don't pay tax on dividends either outside or inside an ISA.Higher rate taxpayers pay 25% tax on divis outside an ISA and nil inside an ISA.

Both pay capital gains tax outside an ISA after using their 8.5k annual allowance.No CGT is payable inside the ISA.

I could direct you to an explanation of the tax credit business, but you won't really want to read it, believe me.