Our general accounts and individual savings accounts (ISAs) are the most flexible type of account offered because you can take your money out at any time. But what are the key differences between a general account and an adult or junior ISA?
In the main, it comes down to tax, which can have a major bearing on your ability to grow your capital.
ISA tax-efficiency
Unlike general accounts, ISAs shelter your savings from the tax liabilities you would otherwise be exposed to as your savings grow. This is because you pay no tax on any interest you earn or income you receive, and you pay no tax on any of the capital gains you might realise. Ever. No matter how big your ISA savings get over time.
It’s the big advantage ISAs have over general accounts.
With a general account, the dividends and/or interest that you earn from your investments are taxable in the year you receive them. In practice, this means having to pay this tax through your next self-assessment. The rate of tax you pay depends on the income-tax bracket you fall into when all your earnings are added up, subject to any savings and dividend tax allowances.
If you sell any investments in your general account and make a profit on them, you may also have to pay capital gains tax (CGT), subject, again, to an annual tax allowance. The flipside, though, is that you can use any losses to offset your gains when you complete your self-assessment form.
Everyone has an annual capital gains allowance below which they don’t have to pay CGT. This covers the profits a person might make in a year selling a second property or business interest, as well as any investments they might hold. And for the 2021/22 tax year it’s set at £12,300 for most people.
But government policies are subject to change, so there’s always a possibility of this allowance being cut in the future.
The same applies to the rates at which CGT is charged, as this too could change. At present, if you are a higher or additional rate taxpayer, you pay 20% on your capital gains (28% if earned from residential property). This falls to 10% (or 18%) if you remain below the basic-rate income tax band.
The difference tax can make
The tax advantages of an ISA can make a big difference to your savings over time.
Imagine you, a higher-rate taxpayer, invest £20,000 a year in a globally diversified stock-market fund.
Imagine also that you earn an annual rate of return of 5% on this money. For simplicity’s sake, we won’t take into account costs but we will factor in current dividend, savings and capital gains tax allowances. We’ll also assume that the money is left fully invested the whole time.
What difference could your choice of account make?
What would be the difference in profit in this hypothetical example if you sold your investments after 10 years? The answer, as the illustration shows, would be more than £8,000.
That’s an extra eight grand in your pocket, just from choosing the more tax-efficient account!
How investing tax-efficiently can maximise returns
Source: Vanguard calculations. Notes: Based on the investment amounts described in the text. The 5% return used in the example is hypothetical and is not guaranteed (it is based on a 100% stock allocation with 1% income yield and 4% capital appreciation). Assumes a higher rate taxpayer with a dividend allowance of £2,000, personal savings allowance of £500, and a capital gains tax allowance of £12,300. Dividends after tax are assumed to be reinvested and all capital gains are crystallised for tax purposes at the end of the final year.
ISA flexibility
The added bonus with adult ISAs is that you don’t have to sacrifice flexibility to gain the tax advantages they offer. You can get your money out just as easily as you can with a general account. You can even withdraw money from our flexible ISA and put it back in again in the same tax year without losing any tax benefits.
This combination of tax treatment and flexibility makes an ISA an ideal vehicle with which to begin investing. What’s more, you don’t have to disclose any of your ISA holdings on your tax return – so there’s less paperwork too!
The only limitation is the amount of money you can put away each year in an ISA, which is currently set at £20,000 (or £9,000 in the case of Junior ISAs).
So if you’re looking to save a lot of money quickly, or have a lump sum in excess of £20,000 to invest, you won’t be able to put it all in an ISA – not in a single tax year, at least.
With a general account, in contrast, there are no annual limits. So if you did have a very large lump sum to invest you could consider putting anything above £20,000 in a general account to begin with, so it’s at least working for you in the market, and then move the funds into an ISA over subsequent tax years. This process is called “bed and ISA”.
Just remember, though, that selling funds in your general account and transferring the proceeds to your stocks and shares ISA can take time, so plan ahead and don’t leave it until 5 April. And if you are contributing to multiple types of ISA in a given tax year, remember also not to breach the overall allowance of £20,000 across all of them
ISA variety
Another thing to note is the different types of ISA out there – aside from the adult and junior ISA distinction. The two principle ones are cash ISAs and stocks and shares ISAs.
You’re only allowed to open one of each type of ISA every tax year. So, if you already have a stocks and shares ISA for the current tax year, you can’t open another one until the new tax year.
Alternatively, you can transfer your existing stocks and shares ISA to a lower-cost provider. Due to the proximity of the tax year-end, though, we would suggest making the most of your current-year tax allowance before doing so, due to how long a transfer might take.
So, no matter what your circumstances, we have an account for you. And, when you combine our account options with our high-quality, low-cost funds and easy application process, you have some great ways of gaining access to world markets.
