One of the small crumbs of comfort from an otherwise grim Budget was the announcement that the investment limits for individual savings accounts (ISAs) were to be increased.

However, as the Budget occurred after the start of the tax year and government finances are constrained, Mr Darling's ISA changes were somewhat complicated:

• From 6 April 2009 until 5 October 2009, the ISA investment limit is £7,200, of which £3,600 may be invested in the cash component.
• From 6 October 2009 to 5 April 2010, the investment limit rises to £10,200 (of which £5,100 may be in cash), but only if you were born before 6 April 1960. Although much of the press coverage has talked about additional investment for the over-50s, you can invest the extra at age 49, provided you reach your 50th birthday by the end of the current tax year.
• From 6 April 2010, the start of the 2010/11 tax year, the age 50 restriction will disappear and the new higher limits will apply for all eligible investors.

The rise in investment limits was well overdue - ISAs started life with a £7,000 ceiling in April 1999 and the ceiling remained at this level until April 2008, when it was increased by a derisory £200. The 2008 increase was accompanied by an increase in the cash component limit from £3,000 to the current £3,600.

A number of ISA providers have already started mailing potential investors seeking top-ups. Even National Savings & Investments (NS&I)) has joined the rush by upping the interest rate on its Direct ISA from a miserably uncompetitive 1.3% to a modestly competitive 2.5%.

With interest rates so low, the investment limit increases will not provide you with significant immediate tax savings. For example, if you are a 40% taxpayer the extra £1,500 you can put into an NS&I cash ISA cuts your annual tax bill by just £15 at a 2.5% interest rate. However, with ISAs it is important to take a long-term view. Once capital is invested in an ISA, then until it is withdrawn (or legislation changes):

• Interest is received UK tax free, other than from cash held temporarily in a stocks and shares ISA.
• There is no UK tax on dividends within a stocks and shares ISA, but tax credits cannot be reclaimed.
• There is no capital gains tax on profits.
• There is nothing to put on your tax return.

The benefit of the shelter from tax builds up over time, thanks to the workings of compound interest: what you save in tax this year is extra capital that will benefit from tax-free returns next year. The shelter is all the more important in the present tax environment. The top rate of income tax rises to 50% next year (42.5% for dividends), with many economists saying there will be further tax increases after the general election - whichever party wins.

Anyone who had maximised their ISA investment since 1999 would by now have placed £77,400 away from the taxman's reach. Some people who started investing in the ISA's predecessor, the Personal Equity Plan (PEP), and kept on investing to the current day via ISAs have portfolios valued at more than £500,000.

ACTION

If you are eligible to top up your ISA, please do not do so until you have sought our advice. The ISA rules mean that you may not be able to place the additional sum with another provider if you have already made an investment in this tax year.

Do not forget that if you currently lack the necessary cash, it is often possible to bed-and-ISA investment funds, ie sell all or part of your personal holding and then repurchase the same fund within an ISA.

ISAs are a long-term investment and growing in importance as tax rates rise and pensions come under increased attack.

 

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This news item is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at August 2009. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.

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