ISAs Unwrapped

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by: MarkeD
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Date: Sat, 24 Apr 2010 Time: 10:42 AM
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We recently ran an ISA surgery and invited our readers to send us their ISA questions. We were inundated with responses and, sadly, couldn't answer them all, but we did do our best to address as many as we could and cover the common themes that cropped up.

With the help of Fair Investment, the Tax Incentivised Savings Association (TISA) and the Buildings Societies Association we've put together a selection of the questions and answers. We also put together an ISA guide dealing with more of the basics, so take a look for more help there, too.

Finally, a big thank you to everyone who sent in their questions. We hope the answers go some way to clearing up any confusion you may have when it comes to ISAs.

Question: Can you tell me exactly all the different types of investments one is able to invest within an ISA, including any leveraged products like ETFs (exchange-traded funds)?

Answer: Within a Stocks and Shares ISA there are a wide variety of types of investment that can be held, provided they meet certain criteria laid down in the ISA Regulations. Where an ISA Manager offers a particular fund or investment within an ISA wrapper, the investor can assume that the investment is ISA-qualifying. It is the ISA Manager's responsibility to ensure all investments held within ISAs meet the requirements of the ISA Regulations.

For ISA investors who wish to make their own decisions about what to invest in (often referred to as a ‘self-select' ISA) it is still the ISA Manager's responsibility to ensure all investments chosen by the investor comply.

Many of the categories (see below) impose listing requirements (for example, that shares are ‘officially listed on a recognised stock exchange').

It should be noted, for example, that not all stock exchanges are ‘recognised' by HMRC; secondary markets - such as the Alternative Investment Market (AIM) - are not regarded as part of the main stock exchange; and being traded on a particular exchange is not the same as being officially listed.

This is why the investor always needs to check the status of any proposed investment with their ISA Manager before giving their instructions.

The categories of qualifying investment that may be held in a Stocks and Shares ISA are:

1. Shares that are officially listed on a recognised stock exchange and pass 5% test (below)
2. Corporate Bonds (loan stocks issued by companies), subject to listing requirements and repayment conditions
3. UK Gilts and European equivalents with more than 5 years to maturity at time of purchase
4. Bonds issued by Multilateral Institutions subject to listing requirements and repayment conditions
5. UK Authorised Funds (unit trusts/OEICS) which qualify either as a UCITS (Undertakings for Collective Investment in Transferable Securities) scheme or as a non-UCITS retail scheme and pass 5% test*
6. Non-UK schemes recognised in UK which pass 5% test
7. Shares in (and bonds issued by) Investment Trusts (as recognised by HMRC) provided the underlying portfolio does not hold more than 50% in bonds etc. which had less than 5 years to maturity when they were first acquired by the company.
8. Qualifying stakeholder unit-linked medium term products which pass 5% test
9. Shares emerging from approved (all-employee) share schemes**
10. Depository Interests (e.g. Crest Depository Interests) where all the investments represented by the DI would qualify if held directly in an ISA
11. Eligible policies of life insurance that pass 5% test
12. Cash held within the Stocks and Shares ISA pending investment in one or more of the above

*5% test - this applies to categories 1, 5, 6, 8 & 10

To qualify for a Stocks and Shares ISA, there must be no guarantee (explicit or implied) that the investor will get back more than 95% of his investment at any point within the first five years. However, if the investment fails this test - i.e. there is a guarantee or expectation that the investor will get back most if not all of his money - such an investment would qualify under the ISA Regulations for inclusion in a Cash ISA.

**Item 9 - This only applies where the ISA investor is entitled to acquire shares from a Savings-Related Share Option Scheme or a Share Incentive Plan.
Such shares may be transferred from the scheme into the investor's Stocks & Shares ISA subject to the annual subscription limit (shares are valued at market value or equivalent on the date of transfer) irrespective of whether the shares would otherwise be qualifying ISA investments

More on Exchange-Traded Funds...

The term Exchange-Traded Fund (ETF) is not defined in tax law or the ISA Regulations.

The London Stock Exchange has defined the criteria they believe a collective investment should meet to become an ETF. These generic features of ETFs are neither regulatory nor statutory requirements. One of the criteria is that the vehicle should be open-ended.

(NOTE: This does not make it an Open Ended Investment Company (OEIC) as defined in the ISA Regulations.)

ETFs are classified as collective investment schemes (CIS), but will not qualify as authorised schemes in the UK owing to corporate governance and structural issues.

Currently, there are no ETFs set up in the UK, but any that might be established would be an unregulated CIS and would therefore not be ISA-qualifying.

ETFs from EEA (European Economic Area) financial centres may be traded through the London Stock Exchange (LSE) but would only qualify for inclusion in an ISA if they were authorised by their home regulator (in another EEA state) as a UCITS and were a ‘recognised scheme' (under Section 264 of the Financial Services and Markets Act 2000). References to ETFs on the LSE website and elsewhere suggest that most ETFs may be ISA eligible but managers must satisfy themselves that any proposed ISA investment meets the appropriate regulations.
An ETF based in one of the designated territories (currently Jersey, Guernsey, Isle of Man and Bermuda) would not qualify under the non-UCITS retail schemes (NURS) regulations because ETFs are not included in the FSA Designation Orders with each of these territories and therefore are not ‘recognised schemes' (under Section 270 of the Financial Services and Markets Act 2000). Such an ETF would not therefore be ISA-qualifying.

An ETF based elsewhere outside the EEA (e.g. USA) would be very unlikely to qualify as a ‘recognised scheme' (under Section 272 of the Financial Services and Markets Act 2000) and therefore would not be ISA-qualifying.

Question: I have an ISA but the interest rate is very low. I want to open a new ISA in another bank but if I do this before 5 April I will lose the bonus payment. If I don't do this I will lose the offer of a better rate as it will change after April. What can I do to solve this problem?

Answer: If you have not subscribed during 2009/10 to your current Cash ISA, there is nothing to stop you opening a new Cash ISA with another ISA Manager.
However, if you have subscribed this year, your only option is to transfer the ISA from your existing ISA Manager to the new ISA Manager, after which you can only add further subscriptions before the end of the tax year (5 April) to the extent that you have not already used your full 2009/10 Cash ISA allowance (£3,600 or, if over 50, £5,100).

In so doing, if you lose your bonus on the current ISA, that is the effect of the terms and conditions that you accepted when you opened the account with your current ISA Manager.

(If you also have a Stocks and Shares ISA to which you have made subscriptions during the current tax year, you must also ensure your total subscriptions to both types of ISA (Cash ISA and Stocks & Shares ISA) do not exceed the overall ISA limit of £10,200).

Question: Providing I do not exceed the permitted maximum amount, can I open or invest in more than one ISA per year?

Answer: You cannot subscribe to more than one ISA of the same type (Cash ISA or Stocks and Shares ISA) during any one tax year. For example, in the current tax year, assume that you have subscribed £2,000 to a Cash ISA with ISA Manager A and now wish to subscribe further with ISA Manager B.

You must arrange to have your current ISA transferred from A to B, after which you can subscribe a further £1,600 (or, if you are over 50, £3,100).

Question: My wife and I each invested £7,200 in a Stocks and Shares ISA in late April 2009. We did not invest in a Cash ISA and we are both over 50 yrs old. Given the changes in ISAs from October 2009, is it allowable for us to invest £3,000 each in a Cash ISA in the current tax year?

Answer: Yes, you can subscribe £3,000 to a Cash ISA with any ISA Manager of your choice.

Although the Cash ISA limit for over-50s is £5,100, you are correct in limiting your subscription to £3,000 because, taking into account your subscription to your Stocks & Shares ISA, this will bring you up to the overall limit of £10,200 for the tax year.

Question: Please explain why I can get investments that pay more after basic rate tax is paid than what the returns from Cash ISAs offer.

Answer: Make sure you are comparing like for like. If you find a deposit account that pays more net of tax than you can get from an ISA, check whether there is a lock-in period.

Many such accounts offer an attractive interest rate which is actually a much lower rate plus a bonus, which will only be paid if the deposit is left in the account for a specified period (e.g. 3 years).

Any deposit account paying interest net of basic rate tax will be better held within an ISA (if that option is available) because there would be no tax deducted.

Question: If I enter a Cash ISA at the end of April 2009 which is fixed for 2 or 3 years, what happens if I want to take out another Cash ISA a year later (end of April 2010)? Will that be the same as having a Cash ISA running and taking a new one out each new tax year?

Answer: The fact that your 2009/10 Cash ISA is fixed for 2/3 years does not affect your ability to subscribe to a Cash ISA in 2010/11 and 2011/12 with any Cash ISA Manager of your choice.

As you will not be making further subscriptions to your 2009/10 ISA, this will not breach the ISA Regulations which do not allow you to subscribe to two different Cash ISAs in the same tax year.

Question: Why are banks allowed to take so long in transferring your ISA to your new provider - keeping your savings at their new lower rate and depriving you of interest at the new improved rate at your new ISA provider?

Answer: When a new Cash ISA product is launched with a particularly attractive interest rate, it can cause an unexpected rush of instructions to other ISA Managers to transfer ISAs out to the provider of the new product and this can cause delays.

However, if you feel you have cause for complaint, you should take it up with the ISA Manager concerned.

Question: Would taking out an equity ISA (as well as the Cash ISA) for the maximum £5,100 be a good idea, since I am not getting much interest on my savings at present? Should I hold both ISAs with the same provider?

Answer: If you decide to subscribe to both a Cash ISA and a Stocks and Shares ISA in the same year, it is entirely your decision whether you choose both with the same ISA Manager or with different ISA Managers. If you choose to use different managers, remember to limit your Stocks and Shares ISA subscriptions so that between the two ISAs you do not exceed the overall limit of £10,200.

Question: Is the ISA provider obliged to permit partial transfers out, or is this left to their discretion?

Answer: Although the regulations allow managers to make partial transfers, they are not obliged to offer this facility (check with your ISA Manager).
Where a partial transfer is made, the current year cannot be split - it must either remain entirely with the existing manager or be transferred entirely to the new manager. Previous years can be split in any way agreeable to investor and ISA Manager.

Question: I already have an online-only ISA with the Halifax which has a 0.5% interest rate. I want to open a new one for 5 April and try to get a better interest rate - can I do this? Can I shut the one I have and open a new one, or can I open a new one and leave the money in this and just not add to it in 2010/2011? Also do you have to be at that bank already to open a new ISA?

Answer: I understand that you have already subscribed to your online Halifax ISA during the current 2009/10 tax year and that you wish to open a new Cash ISA in the new tax year, starting 6 April 2010. So long as you put no further money into your current Halifax ISA after 5 April 2010, you can open a new Cash ISA with any Cash ISA Manager of your choice.

Whether a particular provider would require you to be an existing banking customer before opening an ISA with them will depend on their terms & conditions - you will need to check with them.

Question: Can I get tax relief in year 2010-11 on all sums invested now in a Cash ISA?

Answer: Once you have made subscriptions to your Cash ISA, any interest earned is free from income tax as long as it remains in the ISA. This is irrespective of your tax status.

Question: Is it a good idea to put my children's money into an ISA?

Answer: The clue is in the title - Individual Savings Account. Subscriptions to your ISA can only be made with your own money and the assets held (whether cash on deposit in a Cash ISA or investments held in a Stocks & Shares ISA) belong to you, the individual. ISAs cannot be held jointly or be subject to a legal charge.

You may wish to put money away in your ISA with the intention of giving all or some of it to your children at a later date but, if you change your mind, and end up taking the proceeds out to pay for a lavish party, there is nothing your children can do about it.

Question: If, after 6th April 2010, I no longer subscribe to my current pair of ISAs, but start subscribing to new ones with different companies, and then wished to transfer my now current Cash ISA to a Stocks and Shares ISA, would I have to do so to the Stocks and Shares ISA to which I was then subscribing?

Answer: When you transfer a Cash ISA that includes current year subscriptions to a Stocks and Shares ISA, the subscriptions that you have already made to the Cash ISA are recorded by the Stocks and Shares ISA Manager as subscriptions to that Stocks and Shares ISA in the current tax year.

In your scenario, because you have already made subscriptions to your current Stocks and Shares ISA prior to the transfer, you can only transfer your current Cash ISA into this current Stocks and Shares ISA.

You cannot transfer the current Cash ISA into your previous Stocks and Shares ISA because you would then have subscribed to two different Stocks and Shares ISAs both in the same tax year.

Had you not already opened your 2010/11 Stocks and Shares ISA, then you could have transferred your current Cash ISA into your previous Stocks and Shares ISA, which would then have become your current year Stocks and Shares ISA by virtue of the reclassification of the current year subscriptions previously made to the Cash ISA.

Conversely, in your scenario, after 6 April 2010, you can transfer your previous Cash ISA (into which you have made no further subscriptions) to either of your Stocks and Shares ISAs, because there is no current year subscription to be taken into account.

Question: Why can I find a one year tax-free ISA that pays less (gross) than, say, a one year bond (net after tax)? I'm confused.

Answer: You may not be comparing like for like. You refer to a one-year bond that pays more net of tax than you can get from an ISA.

The one-year bond means, by definition, that you can't get your hands on your money for twelve months or, at the very least, will suffer a penalty if the bond issuer allows you to make an early withdrawal.

The Cash ISA may well allow instant withdrawals at no penalty. Having said that, see whether the bond issuer allows it to be held within an ISA in which case you will be entitled to the bond interest without deduction of tax.

Question: Can you please advise if I am able to transfer over money from one ISA to another? I realise that I would be closing one and opening another? Also, when would be the best time to do this - before or after the April tax year? Also, will my Building Society transfer the money for me or do I have to close and open new accounts myself?

Answer: You appear to have money in a Cash ISA with Building Society A which you wish to move into an ISA with another institution (Bank B). You are perfectly entitled to close your current ISA with A.

However, if you do so, the maximum you will be able to put into a Cash ISA with B will be subject to the annual subscription limit for the tax year.

This means that, before 5 April 2010, depending on your age and whether you have already made any ISA subscriptions during 2009/10, you may be limited to anything from £5,100 to nothing. After 6 April 2010, you will have a new £5,100 limit (irrespective of age).

Question: What are the benefits of a Stocks and Shares ISA over a Cash ISA?
Answer: Stocks and Shares ISAs hold stock market investments (either directly through qualifying shares and other investments or indirectly through qualifying collective funds or investment trusts), which most people will agree should provide a better return over the long-term (at least 5 years).

However, this comes at the price of exposing your savings to a level of risk which could be anything from slightly higher than that associated with deposit accounts (such as Cash ISAs) to a very much higher level of risk - it all depends on the risk profile of the chosen investments.

Question: For the 2009/2010 year I invested the full £7,200 allowance in a stocks & shares ISA. Following the Budget increase in April 2009 up to £10,200, can I put the extra £3,000 into a Cash ISA as this comes under the £5,100 maximum for a Cash ISA?

Answer: You should be able to invest the £3,000 into a Cash ISA.
Question: Can I have an Equity ISA with one company and a Cash ISA with another both within allowed limits?

Answer: Yes you can.

Question: I have read that you should never withdraw money from an ISA because you will lose all the tax free benefits that you have built up over the years. Can you reassure me that my money isn't locked up forever?

Answer: There are different types of ISA available to you, some of which offer fixed rates over a period of time, where others allow instant access and variable rate interest. Normally a Stocks and Shares ISA can be accessed at any time, unless they invest in a structured product or a non-liquid fund.

Question: Sooner or later I have to pay the shortfall on a mis-sold endowment policy covering my mortgage. If it's a case of losing the interest, then why bother with ISAs at all?

Answer: ISAs offer significant income tax and capital gains tax advantages. However the only way to ensure repayment of a mortgage is to have a capital repayment mortgage.

Question: I have already opened an ISA this financial year for more than £5,200, which came from an existing ISA opened over two years ago. Am I entitled to open another Cash ISA this financial year?

Answer: It depends if you transferred the money or withdrew it and then invested it. I am assuming you must have transferred the capital, in which case, yes, you are entitled to open another Cash ISA and invest the full allowance, which is £3,600 if you are under 50 or £5,100 if you are 50 or over (you need to have turned 50 by 5 April 2010).

Question: I have invested the maximum allowable this financial year in cash and am considering investing in a Stocks and Shares ISA. Is the maximum amount allowable in addition to that of a Cash ISA?

Answer: If you are under 50, the maximum ISA allowance is £7,200, of which you may invest up to £3,600 into a cash ISA. If you are 50 or over (you need to have turned 50 by 5 April 2010) the maximum ISA allowance is £10,200, of which you may invest up to £5,100 into a cash ISA.

If you are under 50 and you have used your maximum cash ISA allowance of £3,600, you have £3,600 left to invest into a stocks and shares ISA before 5 April.
If you are over 50, and you did know you had an increased allowance, you must have invested £5,100 into a Cash ISA and you therefore have £5,100 to invest into a Stocks and Shares ISA before 5 April.

However, if you are over 50 and you didn't know you had an increased allowance and have invested £3,600 into a Cash ISA, you therefore have £6,600 of your ISA allowance left. You may invest the entire amount into a stocks and shares ISA, or you may invest up to £1,500 further into your cash ISA and the remainder into stocks and shares before 5 April.

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