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.
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