Savers have been urged to look at a tax-free account (Image: Getty)
Savers have been urged to read up on their options as they could be missing out on “one of the best tax breaks”. A savings expert warns some people may never have heard of one particular account, even though it could be a great way to build your long-term wealth tax-free.
A financial expert has warned there is a potential “missed opportunity” when it comes to ISAs. A key benefit of these accounts is that, unlike other savings options, they are entirely shielded from HMRC, so you can pocket all your growth tax-free.
But it is easy to misunderstand how they work and so miss out on the best-performing accounts on the market. If you are unfamiliar with ISAs, a quick search will reveal that ‘ISA’ stands for Individual Savings Account.
This could give the impression they operate as do other cash savings accounts, where your deposits increase in line with a set interest rate. But the fact is an ISA is just a tax-free wrapper for where you put your cash, allowing you to put away up to £20,000 each year into most of these accounts.
And while you can go for cash ISAs, you can also buy stocks and shares within an ISA wrapper. Investments typically outperform cash savings over the long term, although it is important to note the value of your investments can go up and down.
A lot of people may not know
Joshua Raymond, managing director UK at investing platform XTB, warned many people may not know that stocks and shares ISAs are an option for them. He said: “If you’re new to investing, ‘Individual Savings Account’ naturally sounds like somewhere you put cash, not somewhere you can build a long-term investment portfolio.
“I wouldn’t be surprised if plenty of people simply don’t realise Stocks & Shares ISAs exist. That’s a missed opportunity because the ISA wrapper is one of the best tax breaks available to UK investors.”
Mr Raymond pointed out that you could be needlessly paying an HMRC bill by not putting your funds into ISAs. He said: “If someone invests outside an ISA without realising they had the option, they could end up paying tax on gains or dividends that could have been sheltered.”
Capital gains tax is levied at 18 per cent for basic rate taxpayers or 24 per cent at the higher rate. You can earn £3,000 of gains each tax year without paying the tax.
Another tax to bear in mind here, which ISAs can protect you from, is the tax you pay on your interest earnings. This is levied at the same rate as your marginal income tax rate, which is the income tax rate you would pay on your next £1 of income.
Basic rate taxpayers can earn £1,000 of interest each tax year, aside from their funds in ISAs, and pay interest earnings at their marginal tax rate, of 20 per cent. Once you move into the higher rate, you pay 40 per cent on your taxable interest earnings, and your tax-free allowance drops to £500.
Those on the additional rate pay 45 per cent and get zero allowance, so have to pay this rate on all their interest earnings.
Major changes to tax on savings
Some key changes are coming in for ISAs and the tax rates that apply to savings. From April 2027, the ISA allowance is being restricted so you can only use £12,000 of the allowance for deposits into any type of account. The other £8,000 will only be available for deposits into stocks and shares accounts.
People aged 65 and over will be spared from the new rules and will keep the current allowance. The tax rates that apply to your taxable interest earnings are all going up by two percentage points.
Mr Raymond warned these changes risk making the ISA system “more complicated than it needs to be”. He said: “The biggest reason ISAs have been so successful is their simplicity.
“People understood a straightforward message: invest through an ISA and your returns are tax free. Once you start adding caveats and exceptions, you risk putting people off before they’ve even started.”