Yorkshire Post - April 2007
Contributor : Jonathan Fry

While global equity markets have rallied since March 2003, equity ISA sales have plummeted. At a time when many of us need to be encouraged to provide for our future financial security, is there a reason why investment in equity-based ISAs has been on the decline?

It would seem that the Chancellor, who stands accused as having a major responsibility for the woes of the UK pensions industry, has also reduced the popularity of equity ISAs by imposing a similar stealth tax, abolishing the dividend tax credit.

Prior to 2004, equity ISA managers were able to reclaim the 10% tax taken off at source on the dividends paid by UK companies. Given that the 10% tax reclaim is no longer available, does it now make sense to invest in an equity-based ISA?

While basic rate taxpayers have lost the benefit of being able to reclaim the 10% tax credit, for higher rate taxpayers equity ISAs can still be worthwhile.

The tax liability for higher rate taxpayers on UK dividend income outside an ISA, is an extra 22.5%, making a total of 32.5%. Dividend income earned inside the ISA escapes that extra 22.5% tax charge. So for a higher rate tax payer, holding shares in an ISA is still a worthwhile tax perk.

ISA managers can reclaim the 20% tax deducted at source on the income received from bonds, a name used to describe fixed interest investments. Interestingly, for income investors, funds which hold a mix of bonds and equities, can also be tax advantageous. Providing that at least 60% of the investment is held in bonds, then they are treated as being a bond fund, and qualify for the tax reclaim.

Exemption from capital gains tax (CGT) can also be attractive. All growth in a maxi ISA is free of tax and building up a portfolio of investments in equity ISAs can ensure that none of the gains when the assets are sold are subject to tax. The annual CGT allowance is £9,200 for 2007/2008.

Anyone who has been a regular PEP and ISA investor could well be sitting on quite a substantial gain in the value of previous investments, so the CGT exemption can be important.

For the investor who is prepared to view their stock market ISA as a medium to long-term nest egg, the historic growth realised over five to ten years has been extremely satisfactory. The allowance remains at £7,000 in this financial year, but increases to £7,200 from April 6, 2008.

For the more cautious, or modest investor, a mini cash ISA offering more than six per cent interest tax free provides a savings scheme that is hard to beat. Such accounts often mirror conventional savings accounts in terms of access and easy withdrawals, the difference being that a maximum of £3,000 can be invested during the tax year.

If you are reviewing your savings and investment strategy at the beginning of this new tax year, make sure you give some careful thought to how either a maxi or a mini ISA might be an appropriate option.

© Yorkshire Post 2007