ISAs are better at protecting you from tax on some things more than others

As a general rule of thumb it is better to invest in interest paying funds, e.g. funds that invest into Gilts and Bonds via an ISA. These funds generate interest that is liable to income tax at 20% for basic rate taxpayers. However, when this interest is generated within an ISA it is tax free. Higher and additional rate taxpayers save more.

Dividends generated within an ISA are tax efficient for higher and additional rate tax payers, but for basic rate tax payers the situation is fairly neutral. That is because basic rate tax that is deemed to have been paid before the dividend is paid out cannot be reclaimed even if it is generated within an ISA. So basic rate tax payers pay the same amount of tax on dividends for investment inside an ISA as they do on those held outside of an ISA.

Finally growth funds that are expected to generate good levels of capital gains are possibly the least tax efficient to hold within an ISA. The fact that capital gains can be made without any concern relating to Capital Gains Tax (CGT) should not be underestimated. This is a fantastic tax break and incredibly useful to those with larger ISA portfolios. However every investor has a an annual Capital gains tax allowance of £10,600 (in 2012/13) that can be used to offset gains made outside of an ISA before calculating any liability to CGT. So unless you are thinking of generating significant gains that will total more than this allowance then even investments held outside of an ISA can avoid CGT a liability.

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Blog by Jaskarn Pawar

Jaskarn Pawar is an experienced and award winning Chartered and Certified Financial Planner. He advises people all over the UK on financial planning and wealth management issues to help them reach solutions to fit their personal needs. You can contact Jaskarn on 01604 211234 or by e-mail on jaskarn@investorprofile.co.uk