Is an S&S ISA Worthwhile for Mr Average?

BLB53

If you earn £9k income from investment then you have to pay tax on that income.

Just for the sake of clarity, for the basic rate tax payer, there is no further tax liability on dividend income so in the example above it would make no difference whether the £9K income was provided from shares within an ISA or not - no further tax to pay.

bowlhead99

BLB53 wrote: »

Just for the sake of clarity, for the basic rate tax payer, there is no further tax liability on dividend income so in the example above it would make no difference whether the £9K income was provided from shares within an ISA or not - no further tax to pay.

That's true if the income is dividends from equities, i.e. company shares rather than company bonds or government bonds.

But the average person will not be anything like 100% equities, especially if they are in their 50s. So the proportion of the income that relates to the bonds or bond funds will be taxed at source if you don't use an ISA. If you do use an ISA to hold the bonds/ bond funds, the ISA manager will go and get that tax back for you, as Dunstonh mentioned, which is a good reason to use an ISA. A high yield bond fund paying 5% or 8% is only giving you 4% or 6.4% if you're a basic rate tax payer who hasn't used an ISA.

Only the proportion that relates to the equities funds will be 'dividends' and have no further tax liability to a basic rate taxpayer. And someone who has built up to a 200k fund as described in the earlier example, might find that they are getting 10k of gross interest and dividends a year which combined with a 30-40k salary a decade from now might well be easily pushing them towards, or into, higher rate tax band after all.

Given the cost of using an ISA vs non ISA is often zero, it's can be a no-brainer to wrap your assets in an ISA and forget about needing to keep tax records. That way you don't need to care whether your returns are from equities or bonds or what you paid for them or what you sold them for, because none of it can possibly affect your income tax or capital gains tax situation.

Just going back to the original table of growth in the first post. It was suggested by OP that CGT was only relevant after year 8 when the annual returns were higher than the CGT limit. So it might be worth reminding what CGT actually is: a tax on gains made when investments are sold. At that point you compare your cash proceeds to your costs and the difference is your gain.

If you simply hold a fund worth £100k at the beginning of the year and it turns into a fund worth 108k by the end of the tax year because of 8k growth of the capital value (ignoring dividends)... then ISA or no ISA, the taxman doesn't care. Not because it's below the annual CGT allowance. The reason he doesn't care is because you haven't actually sold anything - you are merely watching an asset change value, there are no proceeds of any sale to compare with any costs.

However after 9 years of enjoying an 8% capital growth, you have doubled your original money, on paper. Your £100k has grown to £200k, or your £50k has grown to £100k, or your £15k has grown to £30k. In those situations you have created a 100k or 50k or 15k gain, on paper. You don't need to pay any tax on that gain until you cash it out. But the fact that your 100k gain was only partly made by asset prices going up in the last one year, and a lot of it was made by asset prices going up in years 1-8 when you chose not to sell... doesn't stop you having a 100k gain problem against an 11k annual CGT allowance.

If you had created a £100k gain, even if you only wanted to cash out a small slice of the pot (to go and buy another investment, or to take out and spend) you would find yourself over the CGT limit, and the bit that you didn't cash out to generate a gain that year would be stored up to carry on growing into a bigger CGT problem in another year down the line when you do another sale.

So - even for someone who is a small investor and only investing £15k ONCE (not every year, and not building up to £100k or £200k level), they can clearly double their money in under a decade and create a CGT problem when they want to take the proceeds of the initial £15k (which turned into £30k) and buy a new car, or a home improvement, or a different income-generating asset for retirement. They would have to try to split the 'cashing in' across tax years to avoid going over their gains limit in any one year.

By gradually selling off assets and buying new ones over time, you can 'manage' CGT matters because you need a pretty big pot to generate a big gain and you can keep selling things off and buying different ones to make small gains on an ongoing basis. But like Dunstonh said, things don't grow in a straight line. If £70k grew at a smooth straight line 10% a year it would turn into 77 and then you could cash in the whole lot for a £7k gain and buy a different asset; investing that 77 in the new asset which turns into £84.7k, sell it again for a new 7.7k gain; and then the third year you might turn the £84.7k into £93.17k for an £8.47k gain.

So overall you made about a 33% return (10% compounded for 3 years) but the £23k of gains was conveniently split across tax years and you never breached the threshold. Great! But that 'just an example' will not pan out like that in reality. The returns over the 3-year period might simply be 0%, 0%, 33%, leaving you sitting on a £93k asset and £23k of gains all at once. You could cash out a portion of the gains by selling half the £93k asset and only making £11.75k of gains which might just squeeze into the annual allowance, but you have to get very good about staying on top of managing this CGT problem. An ISA would have solved it for you.

To summarise:

* Each year an investment portfolio will generate a mixture of interest income, dividend income and unrealised capital gains.

* A basic rate taxpayer:

- pays tax on the interest income;

- has to consider whether the dividend income and interest income taken together pushes him into a tax bracket that results in paying further tax on the dividends; and

- has to manage the CGT which is building up to try to ensure that a future sale of part of the portfolio does not breach the CGT allowance in any one year, and has to keep detailed records of exactly what was paid for his investments (which can be complicated if he holds accumulation units of funds, or he has auto-re-invested dividends).

All of that is avoided by simply holding your financial assets in an ISA wrapper.

Thrugelmir

Too simplistic to expect 8% compound growth. Recent years have been illusory with regards to stock market returns. Markets fluctuate on news. Whether it be Company, Economic, Region and so on. Markets are volatile in normal times.

Invest on a long term plan with long term goals. Spend time choosing the right investments. Be prepared to cut losses. Not just pocket profits.

Onawingandaprayer

...and if you're looking at longish term, now is a pretty good time to get stuck in, with all the recent falls...

Nick_C

I have managed to stay below the 40% tax threshold for a long time, so I didn't worry about putting my equities into an ISA. I've been doing so for the last couple of years though because;

1) I took early retirement and get a pension. I am thinking of going back to work, and my pension + pay + dividends would push me into 40% (which would drastically reduce the net dividends)

2) I reached the CGT limit in January through some lucky trades, and had to stop trading for a few months.

3) I wanted to but foreign equities, and keeping them in an ISA wrapped means I don't have to fill in a tax return.

I pay £12.50 a year for my S&S ISA (with Halifax). It seems a reasonable amount for the benefits it offers.

Onawingandaprayer

gary.ritter2 wrote: »

i thiks its wanna thats I took early retirement and get a pension sell is worth the relatively small price of putting my investments in a S&S wrapper.

Don't wish to be rude, but What????

masonic

Onawingandaprayer wrote: »

Don't wish to be rude, but What????

Spammers can't post links when they first register a new account...

squarebear99

Thanks all.

I realised on my journey home on Friday that I'd got my knickers in a twist differentiating between CGT and tax and when, actually, I would be hit with CGT, so thanks for those who kindly pointed that out without embarrassing me.

The reason I posted originally was that this site's brief questionnaire seemed, in the light of my answers, to be pushing me away from an S&S ISA. I wonder if they ought to make that questionnaire a little less simplistic.

But yes, thank you for taking the time out to help me. It's very much appreciated.

dunstonh

he reason I posted originally was that this site's brief questionnaire seemed, in the light of my answers, to be pushing me away from an S&S ISA.

Hopefully, you are not relying on this site for investment knowledge. It doesnt have a good reputation with investments.

I wonder if they ought to make that questionnaire a little less simplistic.

Or it is too simplistic or steers people away from investments given its avoidance of things investment related in general.