How 16 and 17-year-olds can invest extra money in an Isa
The pros and cons of holding more esoteric investments in an Isa
Isa IHT rules
Can 16 and 17-year-olds invest in an individual savings account (Isa) and a Junior Isa?
Yes, 16 and 17-year-olds can have both a Junior Isa and a cash Isa. This means that in the current tax year they could, in effect, invest £29,000 within these wrappers – £20,000 in the cash Isa and £9,000 in the junior Isa. Anyone can pay into a child’s Isa – parents, grandparents and others.
When the child turns 18 their Junior Isa becomes a regular cash or stocks-and-shares Isa into which they can continue to save and invest – or withdraw from – so their allowance falls back to what it is for adults.
Should I hold speculative/high risk shares in my Isa given the risk of losses which cannot be offset against tax bills?
It is always worth giving thought to which type of holding you shelter within your Isa. For some investors it can be better to hold income-producing investments in their Isa because otherwise they could incur tax. Higher-risk and speculative shares with a growth profile that do not pay dividends will not incur tax until you sell them at a profit.
If you sell shares held in an Isa at a loss relative to what you paid for them, these losses cannot be offset against taxable gains made outside your Isa. But losses realised outside an Isa can be offset against other gains. If the shares have made gains, your annual capital gains tax (CGT) allowance is currently £12,300. However you cannot carry forward unused CGT allowances.
The annual dividend allowance, by contrast, is £2,000. If dividends on investments held outside Isas and pensions exceed this, higher-rate and additional-rate taxpayers incur tax of 32.5 per cent and 38.1 per cent, respectively. The CGT rate on investments for higher and additional-rate taxpayers is currently 20 per cent.
If you sell a property that is not your primary home it is liable to CGT on any profits, and you have to report and pay any CGT on profits of most sales of UK property within30 days. So having investment losses to offset gains against could be useful because of the short time frame in which you have to pay the CGT, points out Rob Morgan, pensions and investments analyst at Charles Stanley.
“You also have greater control over when you take gains as they don’t crystallise until you sell, so you can slice off profits up to the annual [CGT] allowance each year,” adds Laith Khalaf, financial analyst at AJ Bell. “You can’t exercise the same level of control over dividends. These are paid each year by the company so will potentially be taxable as and when they arise.”
But if you do not use up all of your Isa allowance for income producing investments, or have low or no income that is covered by other allowances, then it could make sense to have some of your growth focused investments in an Isa to avoid potential CGT.
What are the inheritance tax rules on Isas?
Isa investments form part of your estate for inheritance tax (IHT) purposes. As with other assets, you can pass on an Isa to a spouse or civil partner without incurring IHT. All other beneficiaries may be subject to tax if the value of the Isa is not covered by your IHT allowance, which is currently £325,000.
Your spouse or civil partner inherits your Isa allowance. So, in effect, when you die your spouse or civil partner receives a one-off Isa allowance equal to the total value of your Isa at the date of your death. This is in addition to their Isa allowance for that year.
Should I hold Aim shares in my Isa?
It is possible to mitigate IHT on your Isa by holding Aim shares in it. Some companies listed on Aim qualify for Business Relief (BR), which means that if you hold them for at least two years and still hold them at the time of your death, you can pass them onto beneficiaries who are not your spouse or civil partner without incurring IHT.
This means that during your lifetime you can benefit from any growth and dividends from the Aim shares tax-free, and potentially spare your heirs an IHT bill on this part of your estate after your death.
Paul Latham, managing director at Octopus Investments, says another advantage of holding Aim investments in your Isa is that you can potentially mitigate IHT on it without having to give assets away during your lifetime. This could be useful if you need them, for example, to fund care home costs or live for much longer and need something to fund this. You also retain control of the assets.
But not every Aim stock offers IHT benefits so it is very important to hold the right ones. They have to engage in qualifying trades so, for example, companies that deal with investments, land or buildings don’t qualify for BR. The company must also be trading. “To benefit from 100 per cent [IHT] relief, the company must qualify for BR at the time of the investment and remain qualifying until the relief is claimed,” points out Jonathan Moyes, head of investment research at Wealth Club.
Aim-traded shares are also high-risk, and the listing requirements for Aim are less stringent than for the main market.
Latham says investors who could consider investing their Isa in Aim shares include those who are likely to have an IHT liability and have a large Isa portfolio. If you invest in Aim shares you should also have a high risk appetite and be able to accept volatility and, at times, falls in the value of your investments.
What benefits do Innovative Finance Isas offer? Do they carry additional risks? How can I minimise these?
Innovative Finance Isas (Ifisas) allow you to hold peer-to-peer (P2P) loans, crowdfunded debt securities issued by companies and bonds issued by registered charities, and cash. They offer the same tax benefits as other Isas and can be opened by those over age 18. What you hold in them counts as part of your annual Isa allowance which is £20,000 for the 2020-21 tax year. You can hold an Ifisa alongside stocks and shares, and cash Isas.
P2P loans are made to private individuals and businesses, and can provide a relatively attractive rate of interest. For example, RateSetter says that you could earn an annualised rate of between 3 and 4 per cent via its Ifisa, Zopa states a projected return range of between 2 and 5.3 per cent for its Ifisas, and Funding Circle states a project return of between 4.5 and 6.5 per cent. Some providers advertise even higher potential rates.
P2P loans are not listed on the stock market so could also provide some diversification in a portfolio focused on listed equities.
Because P2P loans can offer a relatively high rate of income it is beneficial to hold them within an Isa so that you do not incur tax on the income. This is particularly useful for additional-rate taxpayers who do not have a personal savings allowance of £1,000 or £500 like basic-rate and higher-rate taxpayers, respectively, against which you can offset interest from debt investments and cash.
However, as with all debt investments there is a risk that the borrower could default and not repay the loan. This could mean that you don’t earn the promised rate of interest, and lose some or all of your original investment. The loans are made to individuals and small businesses but typically you do not get to choose who or what you lend to.
P2P loans are not covered by the Financial Services Compensation Scheme (FSCS). This means that, unlike with regulated investments, if the provider collapses you would not qualify for compensation from the scheme, currently £85,000 per eligible person, per regulated firm. So it is worth checking the financial strength of the P2P platform you are thinking of investing with.
Some P2P lenders have a provision fund to cover potential defaults by borrowers, so it is worth checking how large this is when choosing the platform.
Others mitigate the risks by ensuring that your investment is spread across various loans so that if one borrower defaults your overall investment is not severely impacted. P2P lenders also make checks on the credit quality of potential borrowers, so check how rigorous their approach is as well as what their historic default rate is.
Because of the risks, you should only invest a small portion of your investment portfolio in P2P loans, maybe up to 5 per cent, and already have a large and diverse portfolio. You may not be able to get instant access to your money should you wish to redeem it: the amount of time and potential penalty for withdrawing it varies from provider to provider. So only invest in P2P loans if you have an investment horizon of three years or preferably longer.
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