B4.05: ISAS - GENERAL

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1 B4.05: ISAS - GENERAL Syllabus Nature of ISAs Eligibility Restrictions on 16/17 year olds Investment components Mini- and maxi-isas Stakeholder products CAT standards Availability of withdrawals Encashment Treatment of ISA on death Nature of ISAs ISAs (Individual Savings Accounts) were introduced in April 1999, to replace PEPs (Personal Equity Plans) and TESSAs (Tax Exempt Special Savings Accounts) PEPs continued to exist under transitional arrangements until 5 April 2008, but have now been reclassified as stocks & shares ISAs TESSAs had a term of 5 years, and no longer exist At maturity, the capital from a TESSA could be invested in a TESSA-only ISA (TOISA) which was restricted to the ISA cash component From 6 April 2008, TOISAs have been reclassified as cash ISAs ISAs offer growth which is generally free of tax, though dividend tax credits cannot be reclaimed Because gains are exempt from capital gains tax (CGT), it is not possible to set any losses against gains on non-exempt assets for tax purposes This is the case whether the gains are crystallised within the ISA or when the ISA itself is encashed There is no minimum or maximum term required to maintain the tax advantages of an ISA However, where equity based, investment considerations imply the expectation that money will be invested for a reasonable period say 5 years or more Eligibility ISAs are fully available to anyone over 18 who is UK resident and ordinarily resident for tax purposes Domicile for tax purposes does not affect eligibility There is no maximum age at which an ISA must be encashed, and contributions can continue irrespective of age Crown employees working abroad but paid by the UK government, and their spouses or registered civil partners are also eligible However, ISAs cannot be taken out by one person on behalf of someone else, nor on a joint basis

2 They cannot be assigned, nor placed in trust The existence of ISAs taken out in earlier years, and/or ISAs resulting from the reclassification of PEPs or TOISAs, does not affect the ability of an individual to invest in an ISA in the current tax year (unless contributions are continuing) Restrictions on 16/17 year olds Individuals aged 16 and 17 can invest in an ISA, but only in the cash component The ability for 16/17 year olds to invest in an ISA was introduced primarily so that they could invest money that they earned in a tax efficient way However, if the investment arises from money gifted by a parent, any interest is classed as the parent s from a tax point of view if total income from all such gifts exceeds 100 pa Interest arising under the ISA may therefore be taxable in these circumstances Investment components There are two separate ISA investment components cash and stocks & shares From 2008/09, any new ISA must be linked to only one of these components and will therefore be either a cash ISA or a stocks & shares ISA An individual can invest in one cash ISA and one stocks & shares ISA (but no more) in any one tax year, subject to overall contribution limits Note however that exceptionally, if a cash ISA is established and transferred into a stocks & shares ISA in the same tax year, it is treated as if the investment had always been in stocks & shares, so it is then possible to open a further cash ISA (within contribution limits) No transfers were permitted between components prior to 6 April 2008 From 6 April 2008, transfers are allowed from a cash ISA to a stocks & shares ISA This is allowed whenever the ISA was established and is not limited only to new ISAs Transfers from a stocks & shares ISA to a cash ISA are still not permitted however The Stocks & Shares component can include direct equities, unit trusts, investment trusts and OEICs, gilts and corporate bonds Shares must be quoted on a recognised stock exchange, but this can be anywhere in the world There are no geographical restrictions on where unit trusts etc can invest Gilts and bonds must have a minimum required term of 5 years to redemption at the time of purchase (or be undated ie have no redemption date) The cash component includes deposits and money funds The test for inclusion in the stocks & shares component is known as the 5% test If the value of the investment is protected from a fall in excess of 5% in the first five years, it can be included only in the cash component Otherwise, the investment can be included in the stocks & shares component Cash can also be held in the stocks & shares component, generally as a temporary measure, but any interest earned is taxable at 20% This is deducted at source by the ISA manager and paid to HMRC

3 There is no further liability on the investor, nor any ability to reclaim the tax deducted, whatever his/her tax position It is therefore not necessary to include such interest in the investor s tax return Mini- and maxi-isas In the past, there has been a distinction between mini- and maxi-isas This distinction no longer applies from 6 April 2008 A mini-isa could include only one of the two investment components A maxi-isa had to include the stocks & shares component, and could include a cash component (but this was not compulsory) The application of investment limits differed between the mini- and maxi-isas, but the differences are no longer relevant In general, the maxi-isa route was useful to maximise the ability of the investor to invest in the stocks & shares component The mini-isa route allowed a separate choice of manager for each component Stakeholder products The cash deposit and medium term stakeholder products introduced from 6 April 2005 are eligible for inclusion in ISAs In practice, deposit accounts meeting the stakeholder requirements are fairly common, but there are few medium term stakeholder products Generally the cash deposit product can be included in the cash component and the medium term investment product in the stocks & shares component, but the usual 5% test applies Because of the availability of these products, CAT standards relating to Charges, Access and Terms (see below) no longer apply to new ISAs Existing CAT standard ISAs continue to be subject to their existing terms however (see below) The main stakeholder requirements for the cash deposit product are: - No charges (other than for extra items such as duplicate statements) - Minimum transaction size no more than 10 - No limit on withdrawal frequency - Withdrawals must be available within a maximum of 7 working days - Interest rate no less than 1% below base rate (compared to 2% below base rate for CAT standard products) - Upward movements in base rate taken into account within 1 calendar month The main stakeholder requirements for the medium term investment product are: - Maximum annual charge 1.5% of the fund for the first ten years and 1% thereafter - No other charges (eg initial charge, encashment penalty etc) - Minimum investment no more than 20 - Investment must be via collectives (unit trusts, OEICs, investment trusts or life funds) rather than in direct holdings of shares etc - The exposure to equities and property must not exceed 60% - Unlike the position with CAT standards, there are no geographical restrictions on investment CAT standards CAT standards were voluntary standards for ISAs and related to Charges, Access and Terms

4 CAT standard ISAs were not (and are not) guaranteed or approved by government, but are intended to be fair and straightforward Although no longer applicable to new ISAs from 6 April 2005, ISAs which were CAT standard at outset must remain so CAT standard cash ISAs must offer an interest rate of at least bank base rate less 2% and have no charges CAT standard stocks & shares ISAs give no guarantee of any particular level of performance, or any guarantee that capital will not reduce They are subject to a limit on the annual management charge of 1.5% for the first ten years and 1% thereafter (1% throughout if established before 6 April 2005) No charges other than an annual management charge can be levied CAT standards for each component were different, and an investor may have a mixture of CAT standard and non-cat standard ISAs In practice, there were many cash ISAs, but few Stocks & Shares ISAs, which were CAT standard Availability of withdrawals There is no minimum period before withdrawals are permitted from an ISA There is no restriction on the amount of any withdrawals There is no tax liability or tax penalty on withdrawals, whenever they are taken, irrespective of size and frequency Withdrawals do not affect the tax treatment of the money remaining in the ISA Because withdrawals are not regarded as taxable income, they do not affect Age Allowance for the over 65s, nor State benefits which are means-tested against income, for example, Child Tax Credit However, for some benefits which are means-tested on the basis of an assumed income derived from capital, ISA funds are included This applies, for example, in the case of Pension Credit The detailed provisions regarding means-testing are outside of this syllabus area Withdrawals do not affect contribution limits So, for example, if a maximum ISA contribution is made in a tax year, a subsequent withdrawal will not affect the fact that no further contributions can be paid in the same tax year Encashment An ISA can be encashed at any time without any loss of the tax advantages enjoyed to the date of encashment There is no minimum term However, contribution limits are not altered by an encashment, even if within the same tax year as the contribution was paid Treatment of ISA on death On death, the tax advantages of the ISA end and the value is paid to investor s estate

5 It is not possible to assign an ISA, nor make it subject to a trust As a result, the fund value may give rise to, or increase, an IHT liability on the estate