6th July 2016
The new tax year saw major changes to the way interest and dividends are taxed. With the introduction of two new allowances plus increases to existing allowances, the Treasury estimate that 95% of savers will no longer pay any tax on their savings. So what does this mean for individuals, and will ISAs still be a useful place to save or will they become redundant?
Previously, for every £100 of interest earned (perhaps interest on a savings account), a basic rate taxpayer paid £20 in tax and a higher rate taxpayer £40. However, since 6 April 2016, basic and higher rate taxpayers have been eligible to receive some savings income completely tax-free through the introduction of a new Personal Savings Allowance (PSA).
The new PSA means a basic rate taxpayer can earn up to £1,000 in savings income tax-free, while higher rate taxpayers earn up to £500. Savings income includes the interest you earn on bank and building society accounts, plus interest from other investments such as corporate bonds and gilts. In this current low interest rate environment, this new allowance is potentially very valuable. A basic rate tax payer would be able to save £100,000, earning 1% interest before having to pay any tax, and a higher rate tax payer can save £50,000 at 1% before paying any tax. There is no allowance for additional rate payers.
These new allowances prompt the question; are ISAs still worth having?
When thinking about this question it is important to realise that these new allowances may have been introduced but they could also be taken away or revised in the future.
It is also worth noting that £1,000 a year interest seems a lot in the current interest rate environment but if savings rates go up in the future to 5%, a basic rate tax payer would only be able to have £20,000 in savings before paying any tax, and a higher rate tax payer only £10,000.
Also in this new tax year, changes were made to the taxation of dividends. The 10% dividend tax credit has been replaced by a new tax-free Dividend Allowance of £5,000. This means that share owners won’t have to pay tax on the first £5,000 of dividend income, no matter what other income they have. However, dividends still count towards the basic and higher rate bands and so may affect the rate of tax paid on dividends received above the allowance. This is where ISAs are useful, as dividends from shares held in ISAs remain tax-free.
ISAs can play a significant part in creating a tax-efficient investment strategy, especially as they not only shelter investment income from tax but also capital gains. Additionally, there is no need to keep records of ISA returns for the taxman as these investments don’t have to be declared on a self-assessment tax return.
The current ISA allowance of £15,240 remains generous and is set to rise to £20,000 next tax year. By having a strategy to use ISAs each year, it is possible, for some, to protect all of your savings from future income and capital gains taxes.
However, it’s also important to realise that ISAs are one of several saving vehicles that individuals can utilise whilst saving for retirement. The pension changes brought freedom and choice for pension savers and means all savings must be considered, whilst planning for retirement. This includes pensions, ISAs, shares and any cash savings, plus that of their partners. Also things like an individual’s tax status, health, longevity, property, and any possible inheritance or additional assets, all need to be taken into account. Well thought out planning could help savers to minimise tax and maximise potential income in retirement.
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