What are the tax benefits of an ISA?
The tax perks of ISAs.
A cash ISA works like a tax-free savings account. So, you don't have to pay any income tax on the interest. It can make a big difference to the return, particularly for higher-rate taxpayers.
For example, if you put money into an ordinary savings account that pays 5% before tax, the rate would drop to 3% after tax for a top rate payer, or to 4% for people on the basic rate.
If you had £3,000 in the account for a year, it would mean the annual interest would drop from about £150 to £90 after 40% tax, and to £120 after 20% savings tax for the basic rate payer.
If you hold money in a bond fund, the income is taxed as interest, so it works in the same way as a cash ISA.
Lesser perks in equity ISAs?
The tax perks on equity ISAs, including property funds, are not so straightforward - and arguably not so generous.
You don't have to pay capital gains tax (CGT) on any growth in the value of your fund when you sell. Sounds good? Well, it might be better if CGT were not already so easy to minimise or avoid.
We each get an annual CGT allowance of £9,600. So we can already make tax-free gains of about £9,600.
Some equity ISAs also invest in shares that pay regular dividends - and there is a tax on dividends. People on the basic rate are charged 10%, which is automatically deducted so they have nothing further to pay. Higher-rate payers are charged at a rate of 32.5% and must make up the difference when they fill in a tax return.
If the shares are held in an ISA, higher-rate taxpayers do not have to make up the additional 22.5% tax on dividends. However, basic-rate taxpayers cannot claim back the 10% tax deducted from dividend income, which limits their advantage to people on the basic rate.
Please note that articles on MSN Money do not constitute regulated financial advice, which recommends a course of action based upon the specifics of your personal circumstances. The articles are intended to provide general personal financial information. We urge you to consult an Independent Financial Adviser (IFA) before making any important decisions about your finances. You can search for an IFA in your local area. Any statement regarding financial services products and tax liability is based on legislation and tax practices as at 6 April 2011, which is, of course, subject to change. The value of any tax benefits or reliefs depends upon the individual circumstances of the investor. When investment performance is mentioned you should remember that past performance is no guarantee of future performance. Where products have an underlying investment content, in many cases the value of the investment can fall as well as rise. For with-profit based investments, there is no guarantee as to the level of bonuses that will be declared, if any. Where mortgages or secured loans are explained do remember that your home is at risk if you do not keep up repayments on a mortgage or other loan secured on it. All mortgages are subject to underwriting, status and are not available to people under the age of 18.
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