George Osborne’s partiality for Budget sweeteners means that from April 6 there will be two important changes to the UK’s tax landscape for individuals. First, there’s a new personal savings allowance, which means basic-rate taxpayers won’t pay any tax on the first £1,000 of interest earned on savings, while higher-rate taxpayers can earn £500 completely tax free (no such luck for additional rate taxpayers).
This new allowance does not just apply to savings accounts: interest from bank accounts, credit unions, building societies, peer-to-peer lenders, interest from government and corporate bonds as well as the interest distributions typically earned on corporate bond funds are all included.
The other major change will be to how dividends are taxed. The current system of a notional 10 per cent dividend tax credit will be abolished. Crucially, all individual investors will now have a new tax-free dividend allowance of £5,000 — although once this is exceeded, the effective rates of tax on the balance will be higher than under the previous system. Under the new system, basic-rate taxpayers receiving less than £5,000 in dividends will find their tax position unchanged, while higher-rate taxpayers could receive up to £21,667 in dividend payments each year before paying more tax.
For many investors, Isas have been a favoured way of holding dividend-paying shares and equity income funds as well as interest-paying corporate bond funds. Given that you can now earn a significant slice of your interest and dividends, tax free outside the shelter of an Isa, some question whether it makes more sense to use this wrapper for growth investments and instead shield yourself from capital gains tax (CGT)?
The answer really depends on the type of investments you hold and your individual tax position. Fundamentally, there will now be some form of tax-free allowance for most types of investment return whether dividends, interest or capital growth, alongside the annual Isa allowance. And there’s little doubt that for the astute investor the new allowances could offer the opportunity for some clever rejigging of how your investments are arranged.
Remember that the main target of the new dividend taxation rules are those who own their own companies and withdraw profits as dividends rather than salary to take advantage of lower tax rates on dividends. For them, a consultation with the company accountant may be advisable.
However, those with a very large share of fund portfolios not held within tax-efficient wrappers such as Isas or self-invested personal pensions may also face a higher overall tax bill. If you are in this camp, one approach might be to wrap your highest dividend-paying assets within the tax-protective clingfilm of the Isa, and make your new annual dividend allowance go further.
As allowances apply to all individuals, you could also consider dividing assets between married couples and civil partners to take advantage of the lower income of one partner and so lower tax rates.
But let’s say you have a fairly conservative investment approach and the bulk of your portfolio is invested in corporate bond funds paying interest. The annual dividend tax allowance won’t make any difference to these and the personal savings allowance may not be enough to cover all the interest, in which case you would want to hold these investments within your Isa.
Alternatively, if you find that both the interest and dividends from your investments fall within the new tax-free allowance bands, then an Isa might be better suited to steer clear of capital gains tax. That said, every individual has a relatively generous CGT annual tax-free allowance of £11,100 so even this is not clear cut. Of course, depending on your individual circumstances, this can easily be used up. You could, for example, sell a property investment and realise a substantial capital gain in the process.
So what is the bottom line? Carry on using the Isa as you’re far better wrapping up your investments in this wrapper than not — the benefits carry on forever. Remember that money held in an Isa is protected from tax, year after year, which means over time you can protect a bigger and bigger amount. Also, spouses can inherit their deceased partner’s Isa allowance, retaining the tax-free status. You can’t inherit their personal savings or dividend tax allowance.
Isas are easy to set up, cost effective and flexible and should be considered a useful insurance policy against future changes to tax — whether in terms of capital gains or income.
It is also worth noting that from April 6, the ability of high earners to shelter money within a pension will be curtailed even more — there will be a further reduction to the limit on how much you can shelter over your lifetime and the annual amount that can be contributed will reduce from £40,000 to as low as £10,000 depending on your income. These changes make the Isa an even more important weapon in your long-term investment armoury. There is no limit on how much you can hold within an Isa over your lifetime and you can shelter a generous chunk of money in this wrapper every year, so make the most of it.
Maike Currie is an Investment director at Fidelity International. The views expressed are personal.
Get alerts on Isas when a new story is published