Common Misconceptions About ISAs

Morningstar debunks myths and misconceptions about ISA accounts and savings

Morningstar 5 April, 2012 | 4:01PM
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The specifics of investing within ISAs can give rise to multiple questions and misunderstandings. The following article will address and clarify certain ISA-related issues and misconceptions.

ISAs must be purchased from your current bank

Investors are encouraged to shop around for the best ISA scheme: you don’t have to stay with your current bank. With interest rates at historic lows, cash ISAs offering interest rates that are above 3% are few and far between. Therefore, it’s worth shopping around for the best deal—it may not necessarily be the deal offered by your bank. Meanwhile, remember that only half of your ISA savings can be saved in a cash account. The remainder--or the entire annual allowance--can be allocated to a combination of the following:

- Shares and corporate bonds issued by companies officially listed on a recognised stock exchange anywhere in the world
- Bonds issued by the UK government or other countries in the European Economic Area
- Units or shares in OEICs or closed-end funds
- Life insurance policies

I don’t like ISAs, they don’t “perform

It is possible that past experiences investing in ISAs has yielded disappointing results. But don’t let that put you off ISAs entirely. The ISA is just the wrapper that enables you to invest tax-efficiently. The investments you place within that wrapper are supposed to “perform,” not the ISA itself.

There are a number of ways to check which fund providers offer ISA-eligible vehicles. The full list of ISA-approved managers is available on this government website and Morningstar’s fund reports also display their ISA eligibility under the Fees section. You can rank ISA-eligible OEICs using Morningstar’s ISA Quickrank tool.

I'm better off putting money in my pension because of the tax relief

There is no single answer about whether your savings should be put into a pension scheme or an ISA. While ISAs allow you easier access to your money, pensions offer some sizeable tax relief incentives. It largely depends on the goals and needs of each investor, so it is a good idea to seek the advice of a financial professional.

Saving towards retirement, whether in a personal or occupational pension, offers full tax relief on up to £50,000 worth of contributions. That is, the UK government will refund the income tax you paid on up to £50,000 of your income if allocated towards a pension plan.

In addition, many employers offer to match pension plan contributions, which is effectively offering a pay rise and well worth taking advantage of: failing to take advantage of maximum employer contributions is failing to take advantage of free money. The nature of the tax rebate system means that it’s higher earners that tend to make the most of these pension advantages.

Pension contributions, however, are not accessible for long periods of time, currently until one reaches 55. In that respect, ISAs offer much more flexibility. When considering your options for retirement savings, it is also worth noting that the long lifetime of a pension plan contribution means that it might be more susceptible to changes in state policy. Thus keeping up with regulatory changes or seeking the help of a professional adviser to help you do so is important.

ISAs are Inheritance Tax-free

No, they are not. The assets you hold within an ISA wrapper will be added to the value of your estate and you will be eligible to pay tax on any amount in excess of the IHT threshold, which at the moment is £325,000.

The impact of an ISA account on your IHT bill can become more palpable with time if savings in your ISA accounts accumulate. Again, to be sure about these tax policies and how they affect you directly, it’s best to speak to your financial adviser.

I don't need an ISA, I don't pay a higher rate tax

Any individual who pays income tax stands to benefit from saving and investing in an ISA. These tax-efficient wrappers give you the opportunity to avoid incurring income tax or capital gains tax on money held within these accounts, irrelevant of which earning bracket you fall into. Cash ISA accounts also tend to offer better rates than non-ISA cash accounts.

I can’t invest in ISAs because I’m foreign

Any resident or anyone ordinarily residing in the UK for tax purposes can put money into an ISA. Residency for tax purposes is fairly straightforward to establish – if you are in the UK for 183 days or more in a tax year, you are a UK tax resident.

There are, however, some exceptions which may complicate matters. For example, you may be counted as a UK resident if you regularly spend three months in the country in a number of consecutive years. In addition, the concept of ordinary residency is not defined in legislation. It basically means you normally live in the UK, but the precise meaning of these terms is subject to interpretation by the HMRC.

To find out more, the HMRC has both an ISA help line and a residency help line, however, some patience is required should you wish to call either.

I can invest in ISAs if I work abroad, as long as I am a British citizen

Similar to the point made above, if you are born in Britain but are no longer a resident of the country for tax purposes, you cannot take advantage of ISA benefits. The only exception is if you work for the crown, as a diplomat or as part of the armed forces from an overseas location.

If you start saving or investing in an ISA in the UK and then go abroad, you cannot continue putting money into the ISA. However, you can keep your ISA and you will still get tax relief on investments held within the ISA. When you return to the UK, you can start putting money in again (subject to the normal annual limits).

I can transfer funds between a cash ISA and a stocks and shares ISA

It depends. Money held in a cash ISA can be transferred to another cash ISA from a different ISA provider, or to a stocks and shares ISA, but you may incur fees to do so. Assets in a stocks and shares ISA can only be transferred to another stocks and shares ISA, not into a cash ISA.

If you do transfer funds from your cash ISA to a stocks and shares ISA, you can then put new money into a cash ISA in the same tax year, as long as you do not exceed the annual limit.

Importantly, in both the case of a cash ISA and a stocks and shares ISA, you must ask your current provider to arrange the transfer and be sure to check whether you will incur costs for the transfer.

Transferring ISAs between providers is free and easy

We certainly believe that it should be, but this is not always the case. Firstly, many providers will impose fees if you want to switch to another provider. Secondly, the process may take some time and require some following up with your current provider to make sure all the necessary paperwork has been sent and received. Thirdly, some providers require advance warning if you wish to make withdrawals, usually 30 days.

I need to keep my investments in an ISA for a year in order to reap the tax benefits

In principle, you don’t. You can take your money out at any time and enjoy your gains or interest tax free. That said, some providers will penalise you or not reward you fully if you withdraw your funds before a certain deadline.

If you’re using ISAs to invest, rather than save cash, then your investment horizon should really be a lot further out than just one year. At Morningstar we’re strong advocates of investing for the long term and if you’re buying into the stock market we’d suggest a time horizon of at least five years—you don’t need to look far back in history to see the potential for short-term losses.

This article was compiled using content from the following articles on
Common Misconceptions Part I
Common Misconceptions Part II
Common Misconceptions Part III
Common Misconceptions Part IV
Common Misconceptions Part V

For more information about investing in ISAs for the 2012-2013 tax year, read "Your 2012-2013 Guide to ISA Investing".

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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