There are genuine tax benefits for all those who hold a cash ISA in the slightly better interest rates, but the benefits of a stocks and shares ISA are less clear for a huge number of people.
Given that the fees for ISA investments are usually the same for non-ISA ones, and are occasionally higher, some people say that anyone starting out on their investment career may be better off missing them out altogether.
So is it true? Are ISAs really the obvious choice they are made out to be?
Capital gains tax
Investors do not pay capital gains tax (CGT) on investments in their ISAs. However, what the sales talk glosses over is that you only pay capital gains tax on any gains in excess of £10,900 – the annual allowance.
This means that you would need to have a significant pot before you paid any tax anyway.
Assuming returns of 10 per cent in a year – which would be a decent gain for a diversified portfolio – you would need to have a pot of £109,000 at the start of the year to be eligible for CGT.
If you made 20 per cent on your money, you could start with £54,500 and not breach the threshold.
Of course, this is assuming you do not have other chargeable gains elsewhere.
Someone who is starting out on their investment career or putting a little aside as they contribute to a pension may well not get near the threshold for some time, meaning that the CGT benefits are unlikely to be a draw.
CGT is charged at 18 per cent for basic rate taxpayers and 28 per cent for higher and additional rate taxpayers.
Dividends
All dividends are issued by companies net of a withholding tax of 10 per cent that is non-refundable, meaning you cannot get it back.
This is paid by the company when they distribute cash to shareholders, be they private individuals or fund managers.
It is non-refundable to absolutely anyone, holders of ISAs or otherwise. For the basic-rate taxpayer, this is the only tax they would ever pay on dividends anyway, as these are taxable at 10 per cent.
For higher and additional rate taxpayers, the situation is different: they will pay 22.5 per cent and 32.5 per cent respectively, inclusive of the 10 per cent withheld at source.
For these investors, there is a marked advantage to holding an ISA – although only if they choose to take out their money.
It may be that they will become basic rate taxpayers when they retire and start to take out their dividends, meaning that it is feasible they won’t benefit either.
Bond income
Income from bonds is the one area where the benefits of ISAs accrue to all. Bond-coupon payments are taxed at the investor’s rate of income tax – 20 per cent for basic rate taxpayers, 40 per cent for higher rate and 45 per cent for additional rate.
However, few people at the start of their investment careers are likely to have a high weighting to bonds.
In fact, many analysts make the case for ditching them altogether for the longer term investor who wants as much growth as possible over a period of decades.
With the immediate outlook for them looking poor as well, it is conceivable that many investors with a long-term horizon could have bond-free portfolios for some years to come.
However, Adrian Lowcock (pictured), investment analyst at Hargreaves Lansdown, says investors would be wrong not to bother with ISAs, even if the benefits are minimal at the start of your career.
"If you are in your 20s or 30s and are a basic-rate taxpayer and putting a bit away each year, it doesn’t look like there’s a huge tax benefit," he said.
"You aren’t looking for an income, so even if you have bonds they will be a small amount."
However, Lowcock points out that you are likely to build up a more significant sum more quickly than you think.
Investors who do not put their savings into an ISA have the worry that their pots will eventually grow to the point that they do qualify for CGT, or they may become higher rate taxpayers, and at that point they will then have a lot of re-organisation to do.
Given that you can only put £11,520 in an ISA a year, you could potentially end up in a situation where it took you a number of years to siphon your money into ISAs, and you could easily end up liable for tax while you do that.
On top of this, the peace of mind that comes with having the money in an ISA should not be forgotten, he says. ISAs do not need to be declared on a tax return, while investments outside an ISA do. This means that with an ISA, you avoid the stress of the process along with the possibility that you might forget or be late and end up with a fine.
"My experience was that when I looked at it later, I thought thank God I had done it," he said.
