ETF investing in an ISA
Investing in an ISA is the most flexible way to protect your wealth from tax hits.
ISAs, along with SIPPs, are the main tax shields available to UK investors over 18 (you can invest in a Junior ISA for children under 18).
You can open a new stocks and shares ISA every tax year and contribute up to your annual ISA allowance which is £15,240 between April 6th 2015 and April 5th 2016.
Any unused allowance is lost and doesn’t roll over into future years.
The big advantage of ISAs is that your investments, including ETFs, grow free of tax on dividends, interest and capital gains once they are safely inside.
This is particularly important as, from April 6th 2016, taxes on UK dividends are increasing. From that point, even basic rate tax-payers will pay taxes on dividends beyond a personal allowance of £5,000 whereas previously they paid none at all. The tax saving for higher rate and additional rate tax-payers is even higher still.
And though the capital gains tax allowance is much more generous, even a small investment can grow over many years to a point where it is exposed to a tax liability.
Investing in an ISA saves you the trouble of worrying about this and all the tax paperwork that comes with it.
You don’t even have to declare ISA holdings on your self-assessment tax form, so it’s well worth using ISAs even when you start out and can’t imagine your investments ever growing big enough to be caught by tax. Calculating twenty years worth of capital gains is no fun at all.
Another useful feature of ISAs is that withdrawals are not subject to income tax and can be made whenever you like, unlike with a SIPP. Thus there’s no danger of income from an ISA pushing you into a higher tax bracket and you don’t have to wait until retirement age to tap your assets.
If you’d like to invest in an ISA then simply select a stocks and shares ISA account from your online platform. In most cases you will not be charged any extra for an ISA account in comparison to a standard investment account.
Most platforms will also track your annual ISA allowance so you can make sure you don’t put too much in.
When looking for compatible investments, a good rule of thumb is to look out for ETFs with the acronym UCITS in the name. All UCITS ETFs are eligible for ISA investment.
The term simply refers to a common set of European Union standards for ETF products that enable them to be used across EU markets, much as you might expect for cars or toys.
If your investment contributions outstrip your annual ISA allowance then it’s a good idea to shelter bond ETFs in your ISAs before equities. This is because bond distributions count as interest which attracts your standard income tax rate rather than the lesser dividend rate.
Note, that commodity ETFs do not make distributions but will be susceptible to capital gains.
If you have space left over in your ISA, plus assets that are unsheltered, then you can get them under cover using the Bed and ISA manoeuvre.
Because you can’t move unsheltered investments straight into an ISA, Bed and ISA just means selling your taxable assets and buying them again inside your ISA, taking care not to exceed your annual ISA allowance.
Selling an investment can incur capital gains tax on any growth, but you can avoid that by staying within your capital gains personal allowance. You’ll also incur costs to sell and buy your investments but once they’re within your ISA they will grow tax-free in the years ahead.