Stocks & Shares ISAs

What is a stocks & shares ISA?

Everyone in the UK over 18 has a £15,240 ISA allowance. You can choose to use all of this for a stocks & shares ISA if you want, or you can put some in a cash ISA and the rest in a stocks & shares ISA. You can also choose to put the whole amount into a cash ISA.

The new ISA rules that came into effect in 2014 mean that you can now split the money between stocks & shares ISAs and cash ISAs any way you like.

It may still be called an ISA, but a stocks & shares ISA is very different to a cash ISA, which is simply a savings account you don't pay tax on. With a stocks & shares ISA you're investing. This could be in things such as:

• Corporate and government bonds. You basically lend your money to a company or a government in return for interest (don't confuse these with fixed-term bonds, which are basically savings accounts held for a certain period of time).
• Shares. You invest in individual companies. Owning a share is like owning a brick in a house wall. If the price of the house (company) goes up, so does your brick (share), and vice versa.
• Funds. Most people use funds when investing. These can include bonds, shares, a mixture of the two, or in some cases, cash. Most funds have a specific theme, around which all the investments are based.

Quick question

What exactly are funds?

They're tax-efficient, but not always tax-free

It's very important you understand what the tax breaks are and whether they really matter to you before you decide to use your ISA allowance for investing.

Unlike the clear-cut tax gain of a cash ISA, stocks & shares ISAs help you save some tax, but not all...

A. You don't pay capital gains tax (CGT) on gains made within a ISA - great if you exceed the £11,000 annual CGT allowance.

CGT is a tax you'll have to pay on the gain you make when selling things such as shares, a second home (you don’t pay capital gains on selling your first home) and jewellery.

So if you buy shares at £1,000 and then sell them for £1,500, you’ve made a £500 gain. You might then have to pay tax on that. But it’s important to understand that...

You’re allowed to make £11,100 of gains this tax year (2015/16) tax-free outside an ISA. So you would ONLY gain using a stocks & shares ISA in a year where you were making total gains over £11,100.

B. Dividends are taxed at 10% in an ISA - but only higher-rate taxpayers gain.

There are two ways you make money from investing. One is when the shares increase in value and then you reap a nice little profit when you sell them. The other is when they pay dividends.

Dividends are a bit like interest on a savings account. If a company makes a profit, it gives some of it back to you - it could be on a regular basis or as a one-off. And just like interest on savings account, dividends are taxed, at 10%. Outside an ISA, basic-rate taxpayers also pay 10%, while higher-rate taxpayers pay 32.5%. So...

Basic-rate taxpayers don’t get any tax gains on dividends from being in an ISA, only higher-rate taxpayers do.

C. You don't pay any income tax on interest from corporate bonds in an ISA.

With corporate bonds, instead of investing in a company’s success, you’re effectively lending money to it for a set time. In return, it'll have to pay you interest.

You're taking the risk that it won't give you the money back, so it isn't risk-free. But the good news is...

If you've got corporate bonds, or bond funds within an ISA that pays out interest, you don't have to pay any tax on it.

If you're investing in corporate bonds outside a stocks & shares ISA, you'll pay your normal rate of tax. So a basic-rate taxpayer will pay 20% tax, and a higher-rate taxpayer 40%.

Still not sure? It's time for a table on the tax benefits of a stocks & shares ISA...

Quick questions:

Is investing right for me?

It's really not a question we can answer - it all depends on your personal circumstances and the amount of risk you're willing to take. But as a rule of thumb, you should invest for at least five years. This allows enough time to ride out any bumps in the market that might see you make a loss on your money.

As such, if you're looking to use your money within the next couple of years, you should probably stick to cash savings such as a cash ISA. See the Top Savings and Top Cash ISA guide for more.

It’s very important to understand that there’s no such thing as the best stocks & shares investment.

Over the long run, historically stocks & shares have outperformed money in savings accounts. But that's no guarantee they'll do so in the future.

Remember, investments can go down as well as up.

Should I put my money in a cash ISA or invest it all?

It depends whether you gain from the tax breaks above and if you're willing to risk your money investing. In a nutshell:

• If you're a basic-rate taxpayer you'd need to do a comparison between the amount of tax you'd get charged on savings outside a cash ISA and the amount of tax on any investments held outside a stocks & shares ISA. If you're unsure you could always stick to the previous ISA situation where you could only split the between cash and investments 50/50.
• Big investors, especially those putting money in corporate bonds, should ALWAYS max their stocks & shares ISAs (leaving no allowance for a cash ISA).
• Only investing? ALWAYS max your stocks & shares ISA as it's often cheaper to invest within a stocks & shares ISA.

Don't confuse choosing funds with where you can buy your ISA

You can buy stocks & shares ISAs from different providers, but for the cheapest offers you want to do it through a website, often called a platform.

Investing in a stocks & shares ISA is a two-stage process. First you need to pick which provider to buy your ISA from, then you need to decide what investments to put in it.

It's like buying bread in a supermarket. You first need to pick where you want to buy the bread from (decide which platform to use), then choose what bread you want to buy from there (your funds).

You'll be charged both for using the platform and buying the funds. To stretch the analogy somewhat, imagine each supermarket charges a different price for its shopping bags.

Some supermarket bags are cheaper than others, but the ones that have the most expensive bags may be the ones that sell the bread the cheapest. So it's a combination of the two factors that needs to be taken into consideration.

Note that while the platform fee is charged by the platform you choose, the company running the funds will be charging you for the funds.

You can transfer your stocks & shares ISA into cash ISAs

This may be useful for people coming up to retirement who don't want to take a risk with their money.

If you're going to do this you'll need to contact your new cash ISA provider and tell them you want to transfer money from your stocks & shares NISA. Never just withdraw the money, you'll lose all the tax-free benefits.

Once you've filled out any forms, the transfer may take a few weeks. If you're opening a cash ISA with a different provider to where your stocks & shares ISA was, then you'll likely pay a closing fee, if you're switching with the same provider, there won't be a fee.

Drip-feeding money in over time reduces risk

It's tempting to try to time the market, but it's almost impossible and even the most experienced investors get it wrong. By pulling out of the market as soon as a share dips or trying to second-guess when a share will reach its peak, you could lose out on sharp recoveries or see the price go down again.

Instead, you should invest on a regular basis - in investment lingo this is called 'drip-feeding' - to smooth out any ups and downs. This will give you an added benefit of something called 'pound cost averaging'.

This is how it works:

If you invested a £10,000 lump sum and bought shares valued at £10 each, you'd have 1,000 shares.

If you bought £5,000 worth of the same shares per month over two months (amounting to 10,000 overall), you'd buy 500 shares in the first month.

But if the share price went down to £9.50 in the second month, you'd be able to buy 526 shares, as the shares are at a lower price.

So, rather than your full £10,000 investment being affected by the drop in share price, only half of your money drops in value.

In this example, a lump sum of £10,000 buys 1,000 shares while two payments of £5,000 buys 1,026 shares. Smaller investing on a regular basis means any drop in share price wont be too noticeable.

Use your allowance by 5 April 2015 or lose it

You must save or invest in your stocks & shares ISA by 5 April, the end of the tax year, for it to count for that year. Crucially, any unused allowance doesn't roll over - so if you don't use it, you lose it forever.

Any savings or investments which stay within the tax-free ISA wrapper will continue to earn interest and reap the tax benefits until you withdraw the money.

So it's possible to have substantial amounts invested within ISAs: well over £100,000 since ISAs began in 1999.

Understand the charges of a stocks & shares ISA

Both the platform and the funds you invest in will cost you money. The main ones to look out for are:

• Platform charge.
  It's as if you have to take a supermarket's bag, and some charge you 50p for it and others charge you 10p. This can either be a flat fee (best for high investors) or a percentage of the value of your funds (the larger your funds, the more it'll cost you).
• Fund manager charge (also known as annual management charge).
  Then you'll also be charged for everything you put in that bag - the funds you invest in. This is the charge by the actual manager of the fund held within your stocks and stocks & shares ISA. This is always a percentage and can typically vary from 0.1% - 1% per fund, depending on which fund you’re investing in.
• Selling/buying funds.
  This is the cost every time you buy or sell a fund on the platform. These can be anything from £0 to £25. So if you're an active trader, looking for a low trading charge should be a high priority.
• Transfer out fee.
  The cost involved in moving your stocks & shares ISA from one platform (provider) to another. This is usually charged per fund, so the more funds you have within your stocks & shares ISA, the more it’ll cost you. However, some platforms don't charge a fee for transferring out.

Is your current stocks & shares ISA overcharging?

Once you've got your head around the various charges, it'll be easier to work out whether your current stocks & shares ISA provider is overcharging you.

A platform might have been cheap at first, but new charging structures mean it may no longer be.

Hargreaves Lansdown, the biggest provider, is now more expensive than some other ISAs.

We're telling you this because we know many people have their ISAs with it. But its new 0.45% platform fee means that for many, it'll no longer be the cheapest platform. It is by no means the most expensive, there are platforms that charge much higher fees, but it is not as competitive as our best buys below.

For example...

If you have £20,000 invested with Hargreaves Lansdown, you’d be paying £90 a year in platform charges. This compares to £50 with Cavendish Online.

The larger your investment, the bigger the difference. £100,000 invested with Hargreaves Lansdown would cost you a whopping £450 a year compared to £250 with Cavendish Online.

Quick question