Effective use of ISAs

Whilst ISAs are well known for being tax efficient, choosing the right underlying investment is also important. Using your ISA allocation wisely does not just mean picking the right ISA provider, but also carefully considering the assets themselves.

Within an ISA wrapper, not all asset classes are treated equally. For example, cash ISAs are currently free of income tax - as are corporate bond ISAs which can reclaim the 20% interest paid on their income. Shares, on the other hand, cannot reclaim any tax credits, and are therefore a little less effective in saving income tax. This is because, in April 2004, the rules changed. Where investors in ISAs used to be able to reclaim the Advanced Corporation Tax paid by companies on dividends, this benefit is no longer available. Therefore, the only income tax benefit now is for higher rate tax payers who will pay no more income tax on dividends paid to them by their stocks and shares holdings.

Having said this, while shares are considered higher risk investments, they have performed significantly better over the long-term compared with bonds and cash. Therefore, the lack of any Capital Gains Tax liability within an ISA remains important. However, whilst making the most of your tax benefits is important, it does not outweigh the need to pick the right assets to suit your needs. Only once you get this right can you start thinking about which tax breaks might be of further help.

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