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Are you making full use of ISA allowances?

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01 April 2013, at 12:00am

DYLAN JENKINS suggests that with the end of the tax year very close, it’s a good idea to check that you have taken full advantage of the allowances for individual savings accounts

AS the new tax year is almost upon us I thought it an opportune time to provide a recap on savings into “individual savings accounts” (ISAs) and the tax efficiency of saving through such plans.

From 6th April 2013 all adults in the UK can invest up to £11,520 each tax year into an ISA. The annual allowance is being increased in April 2013 and it will go up in line with inflation in future years.

You can invest the whole ISA allowance in a stocks and shares ISA or split it and put up to £5,760 in a cash ISA.

It is well worth using as much of your ISA allowance as possible because returns are virtually tax free. Unfortunately, you can’t roll any unused allowance over to the next tax year.

The tax year runs from 6th April to 5th April the following year, so you have until midnight on 5th April 2013 to use your 2012-13 ISA allowance. The 2012-13 allowance is £11,280 with up to £5,640 into a cash ISA.

ISAs were introduced by the UK Government in April 1999 to allow people to save money without the taxman touching it. Since then, the ISA limits have risen from £7,000 to the current ISA allowance of £11,520.

Substantial sum

Capital growth doesn’t affect your ISA limit and you can still invest the entire ISA allowance each tax year. Over time it is possible to build up a substantial sum in these highly tax-efficient tax wrappers and for many individuals ISAs can be used as an ideal counterpart to a pension policy for providing capital and income in retirement.

Unlike pensions, however, ISAs can be accessed at any time and are far more flexible in their structure. For instance, there are no restrictions on what age you have to be to access funds and no limits on the amount you can withdraw at any one time.

It is also worth bearing in mind that your annual ISA allowance can only be saved once – you can’t withdraw the money and then reinvest it. That means that, to get the most out of these savings accounts, it’s important to avoid withdrawing the cash. Once you make a withdrawal, you lose the tax-free status on that money.

Where to save your new ISA allowance

If you decide to invest in a stocks and shares ISA, there are literally thousands of different investment funds to choose from. You should also bear in mind that with a stock market investment, the value can fall as well as rise so you may lose money.

If you are unsure about which fund or funds to choose from (you can invest in more than one fund within a single stocks and shares ISA wrapper), it is worth speaking to an independent financial adviser for help.

Even if you don’t want to invest in the stock market, it is still worth using your cash ISA allowance each tax year. Remember you can save up to £5,760 in a cash ISA in 2013-14 and interest is paid tax-free.

As with standard savings accounts, there are different types of cash ISA, so give some careful thought to where you want to put your money. You may prefer to use an easy-access cash ISA because then you can access your savings whenever you want to.

If, however, you have money you can afford to lock away for a few years, you may be able to earn a higher rate of interest if you open a fixed rate ISA.

If you do decide to put this year’s cash ISA allowance into a fixed rate account, you won’t be able to access the money during the fixed term.

Whilst cash provides a virtually risk-free investment option, there are still a number of issues to consider in today’s economic climate where interest rates stagnate at all-time low levels. In particular, savers face years of having their nest eggs eaten away by the rises in the cost of living.

This stark reality is the result of brutal rate cuts on top accounts and stubbornly high inflation and even if price rises in the economy stay at the government’s target level of 2% per annum, savers will still keep seeing the value of their cash eroded because of today’s very low interest rates.

Any cash savings that are required should ideally be held within the tax efficiency of an ISA wrapper to avoid tax further eroding the rate of interest payable.

For instance, you will need 2.5% before tax from your savings to shield yourselves from 2% inflation. After basic rate tax of 20%, this 2.5% ends up paying out 2% in actual interest, meaning your money is not growing in real terms.

An ISA wrapper can mitigate this to some extent by allowing any interest payable to be untaxed, thus maximising your chances of beating inflation.

It has also been confirmed that the junior ISA allowance will also rise to £3,720 in 2013-14 – up from £3,600 in the 2012-13 tax year. Junior ISAs are long-term, tax-free savings accounts for children.

Children can have a junior ISA if they are under 18, live in the UK and weren’t entitled to a Child Trust Fund (CTF) account.

Like their adult counterparts there are two types of junior ISA:

  1. a cash junior ISA, i.e. you won’t pay tax on interest on the cash you save; and
  2. a stocks and shares junior ISA, i.e. your cash is invested and you won’t pay tax on any capital growth or dividends you receive.

The junior ISA allowance allows parents and grandparents to save for the benefit of a child and is an excellent way of investing within a taxefficient environment for future university fees/house deposit, etc.