I’m just getting starting with learning about investing and so far I have only bought one ETF and a couple of individual shares whilst I’m learning the ropes. I understand the tax advantages of a stocks and shares ISA, but am I right in thinking that at £3 a month it would be too soon for me to jump into signing up for the S&S ISA? Or am I missing some other advantage?
Great question, it’s almost as if we planted this
We can’t give advice but here’s the reasons why someone might want an ISA, even if they’re starting out with a fairly small portfolio:
- The growth in your investments (capital gain) is tax-free
- Your dividends are almost entirely tax-free (some dividends on overseas stocks are taxed at source)
- You don’t need to worry about any admin or tax self-assessment
A capital gain is an increase in the value of your investment. In a normal investing account, that increase is potentially taxable once you realise it i.e. sell the investment.
You have an annual tax-free capital gains allowance each year (c.£12,000 in 2018–19, but check the official gov.uk guidance). That sounds like a fair amount.
However (and here’s the tricky but important point), your capital gain is measured as the growth on your investment since the date you bought it , not the growth year-to-year. And if you’re investing for the duration, it’s not that hard for an originally small investment to grow much bigger.
So, unless you’re investing for the short-term and in relatively small amounts, an ISA will almost certainly be your most tax-efficient route.
ISAs also mean you can avoid the admin and paperwork of tax self-assessment, if you go over the capital gains threshold (or hit any other HMRC reporting requirements). This isn’t too difficult but who wants more on their to-do list?
quote from ‘ISAs are coming!’ blog post
There’s a couple of obvious examples of situations where a small investor might get caught out - if they sold a second property or their investments increased in value over time, due to compound interest.
Capital gains tax (CGT) is tax on the return of an investment from when you bought it. Any investment — stocks, art, property (that isn’t your primary residence).
If you’re planning to invest long-term, either as a Buffett-esque investor or for retirement/financial freedom, through the magic of compounding £11k starts to become a very achievable gain on comparatively small initial investments.
The S&P 500 has grown by c.4.7% per annum over the last 20 years. At that rate of return an investment would have doubled in 16 years and triple after 24 years. Suddenly a c.£11k allowance doesn’t look so large!
quote from the ‘The totally NOT complicated investment tax post’ blog post
Remember that in order to benefit from the Capital Gains exemption that an ISA gives you, you need to purchase the investments that you’ll sell in subsequent years within your ISA. You can’t simply transfer your investments into your ISA in the year that you plan to see them, as transferring your investments means selling them in your regular Freetrade account (GIA) & buying them back, within the ISA.
Sorry for the wall of text but I hope that answers your question?
To add to Alex’s extensive information, it does very much depend on how much you invest.
If your portfolio is within the range of £10,000, it is unlikely that your dividends will exceed £2,000 per year (current tax free allowance) and you are also very unlikely to obtain capital gains of £11,700 (shares’ growth allowance when you sell them [e.g. you buy an ETF for £100, you sell it later for £110, your profit is £10. Up to £11,700 per year is tax free even without an ISA]).
Whilst this is quite general and may not apply to every individual, you can at least keep track of your investment performance, and if you get closer to the dividend/growth values mentioned above, this is when you may want to seriously consider an ISA.
Quick question and probably a stupid one. The capital gains tax allowance this is separate from income tax allowance?
So I have my income tax allowance. I’m over that and paying tax. I know invest shares and sell some for profit. Because I’m above that tax allowance do I need to pay tax? Or do I also have an £11,700 capital gains tax allowance that you’ve mentioned?
In which case also like you say, ISA’s and the cost might not be necessary for starting investors with smaller portfolio’s?
Income tax and capital gains tax as separate allowances, so you can get the benefit of both of them.
This does depend on the individual though, one size does not fit all. There may be people who’d prefer to ignore the allowances and rather keep everything tax free in long term. If you a lucky enough to pick a stock that skyrockets in five years, you may be well above the allowance.
Also remember that the allowances do not roll over to the next year and even in you hold a stock for five or ten years, once you sell, the entire growth will be used against the allowance you have in the year of selling.
To give some context, if you invest £5,000 in company X today, and it becomes £50,000 in 2028, upon selling you will be charged =Tax Rate*(50,000-5,000-CGT allowance)
Ok thanks for clarifying
That means I probably do not need to worry about a Stocks & Shares ISA for at least another year or two.
To this day I was thinking CGT has indexation relief but no more, so much I don’t know.
I am studying tax and never heard of that
Did some reading just now here
From 6 April 2008 taper relief was abolished, and indexation allowance was also removed completely from the CGT computations of individuals and trustees.
Corporation Tax: removal of capital gains indexation allowance from 1 January 2018
Regarding the Stocks & Shares ISA. Will they be automatically renewed each tax year or are we going to get the option on whether we would like to renew or not?
It sounds like my investing amounts are going to be so small in the first few years that I’d be better off sticking with a basic account and considering the ISA down the line. I think at this point the monthly cost of the ISA would wipe out any earnings.
Thanks for the info.
When you apply for our ISA you complete an application form which includes the following statement
“I apply to subscribe to a stocks and shares ISA for the tax year 2018/19 and each subsequent tax year until further notice.”
So it will be a rolling application. There are a couple of things to note on this:
You need to subscribe each tax year for it to roll over and apply in the next tax year without having to complete a new application form again. There is an exception to this, which is the first year (so in the example above 2018/19), if you make an application but do not subscribe in the first tax year your application will remain valid for a subscription in the next tax year.
If your ISA is open with a position we will still charge the £3 a month fee.