Merryn Somerset Webb writes every month for Saga Magazine
and is the editor of Moneyweek magazine
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Beware the ISAs of March
It's March. To most of us that means daffodils and crocuses and a bit of dithering in the morning over whether to wear a winter coat or not. To the financial industry it means something much more serious – that there are only a few weeks left to get us to hand over as much cash as possible before the end of the tax year
For the next few weeks we are all going to have to put up with an unrelenting round of marketing from the big fund management companies desperate to make us take out our ISAs with them. If they do their job well – which they usually do – by the end of the month you will be convinced that if you do not immediately telephone their offices and hand over £7000 you will have missed a wonderful opportunity. Are they right? In that you should use up your ISA allowance, the answer is probably yes. But in that you should do so by calling the phone number on the bottom of one of their ads, it is almost certainly no.
Too many people still think that ISA is an investment in itself, to be bought in its entirety from one fund management group. But it isn't. An ISA is not an investment. It is just a tax-efficient 'wrapper' in which you can put investments. Think of it like self-storage. When you use this you go to one of the companies in question, say Big Yellow, and you buy a cardboard box from them. You then fill up the box with all the stuff you want to store for a few years and they look after it – for a small fee – until you need it again. An ISA is pretty much the same. You buy the box – your ISA wrapper – from a financial provider and then you fill it up with investments every year (up to a maximum purchase cost of £7000).
The absolute key is to buy the wrapper from someone who allows you to put whatever you want in it rather than from one of the big name firms which then allow you to put only their funds in it. The advertising campaigns you will see over the next few weeks (all of which suggest somehow that an ISA is an investment in its own right) aim to get you to simultaneously buy their wrappers and one of their funds to put in it.
Do this and it will cost you - both in cash and in admin. First consider the financial cost. If you buy a fund direct from its producer like this you tend to end up paying completely outrageous and utterly unjustified upfront fees of around 5% (so if you invest £7000 you'll immediately pay out £350 in fees) and sometimes even more.
Then there is the administrative burden of getting into ISAs this way. There is no way you are going to want to stick with the one company and their funds for ever, so you'll end up with the bother and expense of moving your money to another company at some point. Or, if you buy a wrapper and fund from a different company every year, the bother of getting an endless stream of valuation reports and marketing material from all of them. Want to be forced into financial apathy by piles of boring paperwork? This is one of the best ways to guarantee that it happens.
Good news: there is a solution at hand. Buy a Self Select ISA. This means buying the wrapper from a fund supermarket or a stockbroker and then choosing what you want to buy for it. If you go for a fund supermarket ISA you will only be able to buy funds, so you are probably best to get your wrapper from a broker in which case you will be able to hold funds run by any provider at all, individual shares, bonds or even just cash (although you’ll get a lousy rate of interest on it and you are legally obliged to be intending to invest it).
Then you can add money into your wrapper every year and invest it as you like, just as you would with an ordinary share-dealing account. You aren't really investing in an ISA. You are investing via an ISA. Doing this means that indeed the only real difference between an ordinary dealing account and an ISA account should be the tax treatment.
Just as the Big Yellow box discussed above protects your horded belongings from damp, your ISA wrapper protects any capital gains on the investments you've popped into it from tax: if you invest outside your ISA wrapper you will have to pay capital gains tax on anything you make on your investments above the annual capital gains allowance, but if you invest inside it you will not. You might not think you need this – after all not many of us manage to make capital gains of anywhere near the allowance, let alone above it, every year – but it is a good safety net.
If you invest sensibly and leave your money working for you for the long term, you'll be amazed the capital gains you do end up making. If you are a higher rate taxpayer you also get a break on the taxation of any dividends you earn from the investments inside your ISA. You will be automatically charged 10% just as lower rate taxpayers are, but will be charged no more than that. Over the years, that's a tax break that will add up nicely (you pay 32.5% outside an ISA).
* Merryn Somerset Webb writes every month for Saga Magazine and is the editor of Moneyweek magazine.
Merryn's views represent her own opinions and are for general information only. Always seek independent financial advice.
This article was created: 15 March 2007.
This article was last edited: 24 May 2007.
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