Individual Savings Accounts, or Isas as they're more commonly known, are a popular way to save tax-efficiently. But come April 2016, new tax allowances will come into effect that could change the way you use your Isa.
On the savings side, the new personal savings allowance will mean basic-rate taxpayers can receive up to £1,000 of savings interest tax-free, with higher-rate taxpayers eligible for £500 of interest free of tax.
A similar approach comes into effect for dividend income. The new dividend allowance will mean you won't need to pay tax on the first £5,000 of your dividend income. You'll pay tax on any excess, with the rate dependent on the tax band.
These changes create more opportunities for tax-free savings and investments, so picking the best place to stash your money will be essential. These five investment strategies should ensure you get the most out of your Isa allowance.
USE IT OR LOSE IT
Although the new tax allowances mean that many people will enjoy tax-free savings and investments outside of the Isa wrapper, it's still important to take advantage of your annual Isa allowance.
'Whatever your tax status, Isas are a great way to shelter money from the taxman,' says Danny Cox, head of financial planning at Hargreaves Lansdown.
'In the short term, the tax breaks might not seem great, but over time they'll grow. You're effectively building your own tax haven, so make sure you use as much of your Isa allowance as possible.'
As an example, say you put the full 2016/17 Isa allowance - £15,240 - into shares with a yield of 4 per cent. This would generate a dividend income of £609.60, which would be tax-free whether or not it was held in an Isa.
But keep tucking away your annual Isa allowance in similar investments, and even if it were frozen at £15,240, your annual dividend payouts would breach the £5,000 dividend allowance in less than eight years if the investments were held outside an Isa wrapper.
This would happen even sooner if you were already holding other 'unwrapped' dividend-producing investments.
Although their future isn't guaranteed, Adrian Lowcock, head of investing at Axa Wealth, believes Isas are relatively safe whatever the political flavour.
'Future governments will tweak elements of tax such as the dividend allowance or capital gains tax (CGT), but they seem less inclined to remove the Isa wrapper,' he says.
A further advantage Isas have over other forms of savings and investment is that, in spite of the additional tax breaks, you won't pay extra for the wrapper.
It'll cost you no more to hold your investments inside an Isa than outside it, and you can often pick up better rates on cash Isas than on standard savings accounts.
What's more, sheltering your assets tax-efficiently is becoming increasingly important as a result of the new pension flexibilities. 'Isas are an excellent vehicle for decumulation as well as accumulation,' says Damien Paterson, managing director of Paterson Financial Planning.
'After you've taken your tax-free cash from your pension, any further income is taxable. Taking income from your Isa enables you to be more tax-efficient in retirement.'
On top of that, as pensions can be passed on free of inheritance tax, using your Isa to fund retirement is a sensible strategy. This means it's definitely worth taking full advantage of the annual allowance.
DON'T ATTEMPT TO TIME THE MARKET
Everyone's heard the classic investment saying, 'sell in May and go away, stay away till St Leger Day', but while there have been instances where prices do fall back over the summer months, Jason Witcombe, chartered financial planner at Evolve Financial Planning, recommends ignoring these lines.
'There's no right time to invest; it's much more about time in the market than timing when you get in,' he explains.
Rather than hold back and look for investment opportunities, if you have a lump sum to put into an Isa, he recommends investing it as early as possible. 'You'll get a full year of tax-efficient growth, rather than risking tax on any return your money generates outside an Isa,' he adds.
Having a lump sum to invest at the start of the tax year isn't an option for all investors, but a regular monthly savings habit can bring significant benefits as well as fitting with your income stream.
'By investing regularly you can remove some of the issues associated with timing and take advantage of pound-cost averaging,' says Paterson.
Pound-cost averaging involves investing a fixed amount on a monthly basis, with your investment buying more or fewer units or shares depending on the price.
This means that when markets are low you can buy more, boosting the value of your investment when the price climbs back up again.
Clearly this strategy won't always work. With a steady investment, or one that focuses on generating income rather than capital growth, there will be less opportunity to buy in at a lower price.
Lowcock adds: 'A regular savings strategy makes best sense for higher-risk investments. If you're investing into something volatile there will be times when you can buy at a lower price.'
And if you're lucky enough to be able to make the full Isa contribution at the beginning of the tax year, over the years even this will turn into a form of regular saving.
BOOST TAX BREAKS
If you're lucky enough to have a mix of different investments both inside and outside Isa wrappers, it pays to make sure you're holding them in the most tax-efficient way.
Although the personal saving and dividend allowances will mean you'll be able to hold savings and investments free from income tax outside of your Isa, the risk of breaching the allowances over the longer term means that it make sense to hold your income-producing investments in your Isa.
'Even in the new environment, the top rate of income tax is higher than the highest CGT rate, so shelter your highest income payers in your Isa,' Cox explains.
'You'll be able to hold a significant amount of lower-yielding investments outside your Isa wrapper before you use up the £5,000 dividend allowance.'
As an example, to produce £5,000 of dividends, you'll only need £125,000 of investments yielding 4 per cent. But drop the yield to 1 per cent, and you can hold as much as £500,000 before the taxman starts getting interested from an income perspective.
While some careful portfolio manoeuvring will help reduce your tax bill, Witcombe warns against becoming too obsessed about the tax breaks. 'Don't let the tax dictate where you invest,' he says.
'Get your asset allocation right first and then worry about where to hold your investments. If your portfolio doesn't reflect your investment objectives and your attitude to risk, you can lose a lot more than you gain on the tax side.'
CLEAN UP YOUR CAPITAL GAINS
Thanks to the introduction of the dividend and personal savings allowances, all attention is currently on how your income is taxed, but a robust investment strategy will help you minimise your CGT too.
The annual allowance for capital gains is £11,100 (2015/16) and, while this might seem a huge gain to make on your investments each year, if you're a long-term investor and sell a chunk of your holdings each year, it can soon mount up.
Isas are free from CGT, further sheltering you from potential tax bills, so to avoid being caught for CGT, Paterson recommends moving existing investments into your Isa.
'Rather than hold shares or funds until they generate a CGT liability, use your annual Isa allowance to move them into a CGT-free environment,' he says.
'If you use up your annual allowance doing this, you can always buy new shares and funds outside your Isa and, being new investments, the CGT liability will start from zero again.'
You will have to sell your shares to move them, so you could end up with fewer in your Isa as there will be dealing charges and stamp duty to take into account.
To get the best deal, look for a 'bed and Isa' arrangement where some of the dealing charges are waived. For example, at Hargreaves Lansdown, although you'll pay to repurchase your shares, it is free to sell them.
Funds also need to be sold to move them into an Isa. But while there's no stamp duty or dealing commission to pay, you could get caught by initial charges and bid-offer spreads, and because many funds only trade once a day, you'll also be out of the market for 24 hours.
However, with CGT charged at 18 per cent or, for higher-rate taxpayers, 28 per cent of the gain, this could be a small price to pay.
KEEP YOUR PORTFOLIO IN SHAPE
Trimming your tax bill to the minimum is a satisfying part of investing, but it's also important to ensure your portfolio stays in good shape.
While all sorts of funds will be vying for your attention, Cox says it's best to keep the number of holdings to a maximum of 10. 'A large number of holdings becomes unmanageable and, because funds are already diversified, doesn't really give you anything extra,' he says.
As a rule of thumb, he recommends having between five and eight if you've got less than £50,000 in your portfolio, and only increasing this to 10 once the value of your portfolio is into six-figure numbers.
Several strategies are recommended when you're growing your Isa investments. For instance, Cox suggests starting out with a UK-based equity income fund to keep volatility under control, before branching out into higher-risk UK funds such as growth or smaller companies, and then into overseas funds.
Lowcock prefers a more global starting point. 'A global fund will provide a solid, well-diversified base from which to specialise more,' he says. 'Once you've got around £5,000 invested into this, you can turn to more focused funds to add variety.'
Although both recommend taking a more focused approach as your portfolio grows, they both caution against becoming too market-specific.
'If you want to invest in emerging markets, pick a broad fund rather than one that is country-specific such as an India or China fund,' says Cox. 'If one country isn't performing well, the manager can move money to another, saving your investment from being dragged down.'
Finally, it's essential to review your Isa portfolio regularly. Some investments will perform better than others, so make sure you rebalance.
'Look at your portfolio at least once a year and switch investments to keep the asset allocation you want,' says Witcombe. 'Although tax breaks are great, asset allocation is key to meeting your investment objectives.'
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