Best Isa - Your Guide To The Best ISA's On The Market

best isa interest rates

best isa explained Now, let me dispel one myth straight away and it is this - no isa is completely tax free, even the best isa in the world is not free of tax - why? - because there is a tax called IHT or inheritance tax, and surprise, surprise, this still applies to your carefully invested ( so called ) tax free savings. Many, many investors, believe they have managed to avoid paying tax on their investments and it can be a shock when they realise that 40% tax could be due at death. It is estimated that around £0.5bn or one sixth of the annual IHT take of around £3bn comes from PEPs and ISAs - a significant sum! Now it is not my purpose here to offer tax planning advice, as this can be mitigated using several schemes, but simply to make you aware that these are not tax free in the true sense. So what tax are you avoiding by investing in an isa - let's have a look.

best isa rates

The tax saving element of an isa can be split into three parts as follows:

1. Interest on savings

2. Dividend income

3. Capital Gain

If we start with interest on savings, as a standard rate taxpayer you would normally pay tax at 20% on your savings interest, and for a higher rate tax payer this would be 40%. All interest earned within the isa is tax free. Now the next one is crafty, and most people are unaware of it. When isas were first launched investors could reclaim the 10% tax paid on dividends (income paid to people who hold shares) so stocks and shares isas were completely tax free.

However, in April 2004 the 10% dividend tax credit was scrapped, so for basic-rate taxpayers dividends are taxed as outside the ISA wrapper. Who said ISAS were tax free!!! - this is Gordon Brown at his best, giving with one hand and taking with the other. So for basic rate taxpayers dividends are taxed at 10%. Higher rate taxpayers are taxed at the same rate as standard rate tax payers of 10%, which is well below the 32.5% charged outside the ISA wrapper for them, so they are in fact better off here.

Now the final element is Capital Gains Tax or CGT, which is applied to gains made on assets such as property and financial investments. Those shares or stocks held inside the ISA wrapper are completely free of CGT, whilst outside the ISA wrapper one can currently make a gain of up to £9,600 before CGT is due. Given that the stocks and shares isa maximum allowable is £7,200 pa , you can begin to appreciate the length of time these investments need to be held in order to be considered 'tax free' . If you are going to invest in stocks and shares isas, then to take full advantage you really need to be investing the maximum each year. If you are only investing small sums, then the costs of buying and managing the isa could outweigh any savings in tax in the long term. Now whilst you do not pay any CGT on gains within your isa, if you make an losses on ISA investments these cannot be used to reduce CGT on gains from investments outside the ISA ( sorry!!)

OK, that's about it on tax and the isa. As you can see from the above, it is not quite the 'tax free' product it first appears. We may have to pay Inheritance tax on death, and we certainly have to pay the 10% dividend tax, so the government is economical with the description at best. Having said that, provided you use the stocks and shares isas with the maximum amounts on a regular basis, and take a long term view of your investments, then isas do provide the opportunity for tax savings in the long term. You will need to ensure that you have some excellent tax planning in place in order to avoid negating any gains with the IHT - but that's' another story.

Finally, I thought it would be useful to add a page of frequently asked questions which I hope will provide answers to topics I haven't addressed elsewhere and which will help you in your search for the best isa available.

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