Index tracker in ISA

breithorn

I am considering investing in an index tracker , as far as I understand any didvidends can be re - invested in the tracker.
If the tracker is not in an ISA does that mean that I would pay tax on the dividends.

Aegis

breithorn wrote: »

I am considering investing in an index tracker , as far as I understand any didvidends can be re - invested in the tracker.
If the tracker is not in an ISA does that mean that I would pay tax on the dividends.

Yes, although there's no difference between dividends in an ISA and dividends in the hands of a basic rate taxpayer. The advantages of an ISA are the higher-rate tax exemption on dividends and the total exemption from capital gains tax regardless of the amount of growth you get.

oldtoolie

Many funds come in two types:
- accumulation where dividends are incorporated into your investment and you pay tax when you sell the fund.
- income pays you dividends which you pay tax on in the year you receive them.

---

As Aegis points out below, I was completely wrong. I could hide my embarrassment by deleting this post but I won't. Here's a good story on the point:

http://monevator.com/2011/09/15/income-tax-on-accumulation-unit/

Aegis

oldtoolie wrote: »

Many funds come in two types:
- accumulation where dividends are incorporated into your investment and you pay tax when you sell the fund.

For accumulation units there is still a declared dividend on which tax is due.

breithorn

Thanks for the replies everyone.
So am I to understand that unless I'm a higher rate tax payer there's no advantage to having the tracker in an ISA, as far as paying tax on dividends is concerned ?

jem16

breithorn wrote: »

Thanks for the replies everyone.
So am I to understand that unless I'm a higher rate tax payer there's no advantage to having the tracker in an ISA, as far as paying tax on dividends is concerned ?

No unless you are close to the higher rate bracket and the dividends push you into it.

However there is no disadvantage to using an ISA so why not use it as it saves you thinking about tax implications.

dunstonh

So am I to understand that unless I'm a higher rate tax payer there's no advantage to having the tracker in an ISA, as far as paying tax on dividends is concerned ?

administration and capital gains tax (depending on how much will end up being involved). Outside of the ISA you will be required to keep a record of each transaction and cost for CGT purposes. Inside the ISA you will not.

There is usually no cost of an ISA wrapper compared to unwrapped (or other wrappers). So, you may as well use it even if there is no income tax benefit at this time.

jnbr

Aegis wrote: »

Yes, although there's no difference between dividends in an ISA and dividends in the hands of a basic rate taxpayer. The advantages of an ISA are the higher-rate tax exemption on dividends and the total exemption from capital gains tax regardless of the amount of growth you get.

Can you clarify that? According to www. direct. gov. uk/en/MoneyTaxAndBenefits/Taxes/TaxOnSavingsAndInvestments/DG_4016453 dividends are taxed at 10% for incomes below £35000. Are you saying that tax is still charged even if the tracker is in a tax exempt account? And if that is the case then what earthly use are ISAs if cash ISAs pay less than inflation and equity ISAs are still taxed?

Or have I, as is quite probable, misunderstood something?

jem16

jnbr wrote: »

Are you saying that tax is still charged even if the tracker is in a tax exempt account?

That is correct. The 10% is a tax credit and cannot be recliamed.

However a higher rate taxpayer would not have to pay the extra tax due.

And if that is the case then what earthly use are ISAs if cash ISAs pay less than inflation and equity ISAs are still taxed?

Cash ISAs can pay more than non-ISA accounts, especially for higher rate taxpayers.

S&S ISAs are free from CGT (for all) and dividend tax for higher rate taxpayers.

middlepuss

If there is no disadvantage to having your savings and investments in ISAs, put them in ISAs.

It's possible you might benefit from being in an ISA in the future if your income rises, the tax-free capital gains allowance is scrapped, or... who knows what might happen.

Linton

jnbr wrote: »

Can you clarify that? According to www. direct. gov. uk/en/MoneyTaxAndBenefits/Taxes/TaxOnSavingsAndInvestments/DG_4016453 dividends are taxed at 10% for incomes below £35000. Are you saying that tax is still charged even if the tracker is in a tax exempt account? And if that is the case then what earthly use are ISAs if cash ISAs pay less than inflation and equity ISAs are still taxed?

Or have I, as is quite probable, misunderstood something?

No - this is a confusion. No tax is charged on dividends. What happens is an accounting sleight of hand - it is assumed that a notional 10% tax on dividends has been paid as part of the company's corporation taxes and you therefore get a tax credit to confirm this which satisfies the tax requirement.

However higher rate tax payers do get charged the extra 20% which is where the main financial benefit of S&S ISAs come in.

The other benefits include protection from Capital Gans Tax and perhaps more importantly for most small investors, you do not need to keep detailed records for 7 years to confirm to the tax man that you should not pay extra tax on your investments.