Savers are being urged to make the most of their Individual Savings Account (ISA) allowance ahead of the Autumn Budget later this month, amid speculation that Chancellor John Healey could increase capital gains tax (CGT) to align it more closely with income tax rates.
CGT is a levy on the profit made when selling or disposing of an asset that has increased in value. For example, if you buy a share for £1,000 and later sell it for £2,000, you have made a capital gain of £1,000, which is the part taxed rather than the overall £2,000 figure.
ISAs can shield savers from CGT by exempting all profits from taxation, as you do not need to declare any investments held within an ISA or any profits made from selling them. When you withdraw cash from an ISA, you can take out the capital and gains entirely tax-free.
How ISAs protect your money
An ISA is a savings account with an overall limit of £20,000. Unlike a standard savings account, any interest you earn is completely free from income tax, which means the money is protected from any potential hikes imposed by the Labour Government on October 28.
Michele Tieghi, a London-based financial expert and the founder and editor of Psyfi Money, told the Daily Express: "You are allowed to save or invest up to £20,000 across your ISAs every tax year. One of these ISAs is a Cash ISA, which provides a useful way to shield interest from tax and keep it in your hands."
He added: "You don’t need £20,000 to benefit from ISAs, though; even if you put a small amount away each month, keeping it in a Cash ISA means the interest builds over time, without you worrying about a tax bill."
Example of tax savings
"For example, if you saved the maximum tax-free amount of £20,000 into your Cash ISA, paying a 4% interest, you could earn £800 tax-free," the expert said.
The expert added that the same savings outside of a tax-free wrapper would count towards your Personal Savings Allowance (PSA), which is the amount of interest you can earn outside of a tax-free wrapper without paying tax. This allowance is currently £1,000 for basic-rate taxpayers who pay 20% tax, and £500 for higher-rate taxpayers who pay 40% tax. Additional rate taxpayers do not have a PSA, so all interest earned outside a tax-free wrapper is taxed.
He explained: "If your Personal Savings Allowance is £500, you would pay 40% tax on the remaining £300, which works out to £120, leaving you with £680."
Choosing the right bank and upcoming changes
He continued: "Essentially, Cash ISAs are a great way to save while not paying tax on the interest you accrue. These savings from the tax allowance may seem relatively minor over an annual period, but over the course of multiple years, they can be the difference between a healthy emergency fund, a family holiday or a new car."
However, savers have been urged to be mindful of which banks they choose to use for an ISA. Mr Tieghi explained how interest rates vary between providers, so choosing the best one can make a "big difference".
He said: "If you’re under-65, it is also worth remembering that changes are coming to Cash ISAs in April next year. The tax-free amount you can put into your Cash ISA will fall from £20,000 to £12,000, while the overall ISA limit of £20,000 will stay the same.
"This means that, if you are impacted by the Cash ISA limit falling, you’re free to invest £12,000 into your Cash ISA, and a further £8,000 into your Stocks and Shares ISA if you wish to."
