Isa tax trap

By DAILY MAIL REPORTER
Updated: 19:00 EST, 17 October 2003

 

TAX breaks are a big incentive for investing, but they shouldn't be the sole reason for putting your money into a savings plan.

Letting 'the tax tail wag the investment dog' by choosing a scheme for its tax benefits rather than its investment objectives is a common mistake. Yet the Government risks fuelling such a scenario when it changes the rules on Individual Savings Accounts (Isas) next year.

From April 2004, Isas that hold shares will no longer be able to recoup the 10% tax paid on share dividends. So investors in UK equity income funds, for example, will see their income reduced.

Research by independent financial adviser (IFA) Bates Investment Services shows the Government will net £35m year just from this sector alone, based on average pre-tax income of 4.35%. The changes will also

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PAUL BUSUTTIL, 35, from Salford, and his partner Donna Carney, 34, pictured with their children Courtney, seven, and Paul, four, both have Isas with CIS (the Co-op). Their savings, about £1,000 each, are invested in the CIS with-profits fund which in turn invests in bonds, property and shares. This fund, being run by an insurer, is different in structure from other pooled funds such as unit trusts so the couple's savings are classed as 'insurance' Isas. These types of Isa are taxed more favourably than normal Isas, so the investment gains can be slightly higher than a non-insurance Isa equivalent. Paul, a mechanic, says: 'It all helps as we are saving for the children to give them a head start in life.'
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affect the end value of such an investment. The total return on £7,000 in a UK equity income fund after ten years, assuming the investment grows by 7% a year, would fall by £543 to £13,227. This is an 8% loss, Bates says.

However, Isa funds will still be able to reclaim the 20% tax on income paid by bonds, the IOUs issued by governments or companies.

But the funds must have at least 60%invested in bonds to qualify for the tax break. Otherwise, the whole fund is treated as a shares fund and won't be able to reclaim anything after April 2004.

So with a better tax break on bonds, some investors will undoubtedly head for them rather than shares. Banks and financial salesmen will find it easier to sell the perks of bond funds, even when shares are a more appropriate investment.

Another product that may get a boost is the poorly subscribed insurance Isa, offered by only nine companies. You can put up to £1,000 a year into it, if you have not already taken out a £7,000 maxi Isa.

Bad press about insurance-inked savings plans, such as endowments, combined with a small annual allowance, has limited the take-up.

But insurance Isas are taxed differently to normal Isas. They get back the 20% tax on bond income irrespective of the total amount of bonds in the fund.

This gives insurance Isas an advantage over normal Isas which cannot reclaim the tax. And again this may mislead investors into selecting the wrong scheme for them.