Tax-efficiency of S&S vs cash ISAs

NickBFS

I have only started perusing this area recently so apologies if the question has already been addressed in the past (my search did not return an obvious thread on this issue).

I have 80K to save/invest. My intention is to put 20K in a cash savings account and to invest 60K in shares (ETFs, in fact) . CLearly, I will not be able to put all of that in an ISA wrapper in one go so the question is: what should I prioritise for my 24-25 (still untouched) ISA allowance: put 20K of the shares in a S&S ISA or put 20K cash in a cash ISA? 

For the sake of the discussion, I will assume that my savings, dividend and CGT allowances are all used up from other savings/investments/disposals of investments (which is likely to be true, at least for savings and for CGT). I also expect my income to keep me within the basic rate tax band (but I think that, even if I ended up reaching the higher rate, this would not change the outcome in terms of comparative tax efficiency of cash ISA vs S&S ISA).

For cash, assuming a typical interest rate of 5%, putting the money in a cash ISA will save me £200 in tax compared to being saved in a non-ISA account.

For shares, the ETFs I plan to invest in would normally generate about 2% in dividends. I also assume a capital growth of about 9% to 10%. So, for 20K invested outside an ISA wrapper, this would mean dividend tax of approximately £35 (8.75% rate of tax) and virtual CGT liability of £180 to £200 (which may or may not be realised in this or the next tax year but will probably have to be paid at some point in the future).

Based on this, it seems to me that prioritising the use of the ISA allowance for the S&S is marginally better. Does that make sense or am I missing something here?

masonic

It will likely be more than marginally better if you think long term. CGT accumulates and it is likely to be far more of a problem years down the line. I'm glad to have my investments from 2005 onwards safely wrapped up in a S&S ISA.

NickBFS

masonic said:

It will likely be more than marginally better if you think long term. CGT accumulates and it is likely to be far more of a problem years down the line. I'm glad to have my investments from 2005 onwards safely wrapped up in a S&S ISA.

That's true but that is also because payment is deferred until disposal, whereas the tax is paid more progressively on savings income. Transaction costs and spread aside, selling and buying the same investment each tax year would diminish the impact of taxation so it would not seem quite so brutal but, ultimately, the difference is probably not quite as stark as it feels like.

masonic

NickBFS said:

masonic said:

It will likely be more than marginally better if you think long term. CGT accumulates and it is likely to be far more of a problem years down the line. I'm glad to have my investments from 2005 onwards safely wrapped up in a S&S ISA.

That's true but that is also because payment is deferred until disposal, whereas the tax is paid more progressively on savings income. Transaction costs and spread aside, selling and buying the same investment each tax year would diminish the impact of taxation so it would not seem quite so brutal but, ultimately, the difference is probably not quite as stark as it feels like.

Back in the olden days when there was a generous annual allowance for CGT, that was certainly true even for a 6-figure portfolio. Helped of course by the fact anti-bed & breakfasting rules are rather easy to get around for those holding funds. When the allowance is only £3k, it starts to look quite challenging even at the £60k level. Give it a month, and the dust will probably be starting to settle on a new CGT regime. I can only guess at what may be coming, but it is unlikely to be good news overall for unwrapped investors. Probably worthwhile deferring any big decisions until after the budget.

Albermarle

A practical consideration is with an unwrapped savings account, you personally will not have to do anything. The provider will report the savings interest to HMRC and they will adjust future tax codes to get back any tax owed.
With unwrapped investments you have to keep records of buys and sells and dividend payments and report them to HMRC. 

masonic

Albermarle said:

With unwrapped investments you have to keep records of buys and sells and dividend payments and report them to HMRC. 

In addition, with an ETF portfolio, you have the added complexity that these are offshore funds, so you need to confirm they are UK reporting and look up and declare the Excess Reportable Income posted by the fund house every tax year.