Unit Trusts & ISAs

Individual Savings Account (ISA's)

ISAs are very tax efficient savings vehicles as they allow you to invest in either cash and/or stocks and shares without paying any income or capital gains tax on them. ISA funds are, however, included in your estate for the calculation of inheritance tax. Since April 2008, all PEPs have automatically become Stocks & Shares ISAs and are subject to ISA rules and regulations.

Because ISAs are so tax efficient the amounts that can be paid into them is restricted in each tax year. The maximum allowance for 2022 is £20,000. ISAs can be a combination of cash and/or stocks and shares in any proportion but you can only have one ISA provider per element in any one tax year e.g. you must put all of your cash ISA allowance with one provider and the same applies to the stocks and shares element.

In 2017, the Government introduced the Lifetime ISA for those over 18 and under 40. This will allow up to £4,000 of savings each year to which the Government will add a 25% bonus. Contributions will be made with the individual’s own cash. This additional bonus will be payable up to a maximum of £1,000 for each year between the ages of 18 and 50. The proceeds can be used either for house purchase or for retirement from age 60 onwards. The contributions count towards your overall £20,000 ISA limit.

On death, a surviving spouse or civil partner can inherit a one-off additional ISA allowance equivalent to the value of the deceased partner’s ISA at the date of death – or the value of cash or investments passed on, whichever is higher.

Aside from the investment tax advantages that ISA's offer, they also allow you to take a tax-free income from the plan without impacting on your income tax status and any age allowances.

There are hundreds of different ISA providers to choose from, but at Isis Financial Planners we favour using a "supermarket provider" (this name does not refer to a "High Street" supermarket!). This type of provider allows investors to select funds from a wide range of fund management groups which isn't possible with a single plan manager. This means that we can select the best performing and most suitable funds for you from various fund management groups.

Portfolio of unit trusts

A unit trust account is very similar to an investment ISA but it doesn't have the same taxation advantages in that any income is taxable and gains are subject to capital gains tax if they exceed the annual exemption. On death, the plan proceeds would form part of your estate for inheritance tax purposes but this is no different from an ISA.

In respect of the potential for capital gains taxation, it will be important to utilise the individual annual capital gains tax exempt amount of £12,300 (for the tax year 2022/23). By using this allowance for switches and transfers to your ISA account, it should be possible to avoid capital gains taxation although this cannot always be guaranteed of course.

Capital gains tax would become payable if a gain of over and above the annual exemption is generated. The tax rate is 10% for basic rate taxpayers and 20% for higher rate taxpayers with gains being added to income. Higher rates apply to residential property not covered by principal private residence relief.

As for an ISA provider, we would favour using a supermarket of funds allowing access to a variety of suitable funds and investment fund management philosophies. It would make sense to use the same overall umbrella provider for a portfolio of unit trusts and ISA for simplicity of administration.

Onshore investment bonds

Onshore bonds have a special way of being treated for taxation purposes. Essentially the underlying fund is taxed at a special rate applicable to life offices. This means that returns from these bonds are treated as having suffered savings rate tax of 20% already. A basic rate taxpayer has no further tax to pay while, for a higher rate taxpayer, there is, in effect, a 20% tax credit. Investment bonds are technically insurance plans. They do contain a very small element of life insurance and hence it is necessary for there to be a life, or lives insured, although there is no underwriting involved. There are many life insurance companies that offer this type of plan and nearly all offer a wide range of funds.

In addition, it is possible to take up to 5% p.a. of the amount invested as a withdrawal in each policy year for up to 20 years and this is treated as a return of capital over this period. No income tax is therefore payable on withdrawals of 5% or less at the time they are taken - the tax liability is deferred until the bond is fully encashed. The 5% limit is also cumulative, so if no withdrawals were made for a number of years but income were required at a later stage, more than 5% could be withdrawn without incurring a tax liability.

If withdrawals are made which are in excess of the 5% limit, a calculation is made to work out the gain and higher rate taxpayers will pay income tax (not capital gains tax) on the gain at 20% - the difference between the savings rate and the higher rate. A similar calculation is made when the bond is fully encashed. The gain is 'top-sliced', which means that it is spread over the number of years the bond has been owned.

As a tax charge arises only when money is withdrawn from the bond, rather than when there are distributions in the underlying funds or funds are switched, it may be possible to time withdrawals to take advantage of changing personal circumstances. For example, an investor might become a basic rate taxpayer in retirement and choose to encash the bond then when the effect of top-slicing relief could reduce or eliminate altogether the additional tax liability.

Offshore investment bonds

Offshore bonds are similar to onshore investment bonds but are normally based in jurisdictions where there is little or no local taxation of non-resident investors' funds. This means that the funds should grow at a faster rate - this feature is often referred to as 'gross roll-up'.

As there is no corresponding 'tax credit' for offshore bonds, a higher rate taxpayer will pay 40% on all gains over the 5% cumulative limit, while a basic rate taxpayer will pay 20% on gains above that limit. Withdrawals of less than 5% p.a. are, as with onshore bonds, not subject to tax when taken, and no entries fall to be made on the tax return.

As with onshore bonds, offshore bonds benefit from top-slicing relief.

In some offshore jurisdictions, investor protection can be an issue. We would only recommend bonds based in countries such as the Isle of Man, the Channel Islands and Ireland, where investor protection is as good as that provided in the UK.

Offshore bonds also have access to a wider range of funds than onshore bonds.

Often, offshore bonds carry higher charges. There are a number of commercial reasons for this, including higher marketing costs and the fact that the life companies cannot claim tax relief for their expenses. There are specific reasons why we would recommend an offshore bond to a client dependent on individual circumstances such as your domicile or future residency status.

Fund rating and monitoring

This fund selection should be consistent with your attitude to risk and the asset allocation agreed.
There are a number of research tools offered by well-known, reputable organisations such as Standard and Poors or Morningstar. The one we mainly use is the Financial Express Crown Ratings.

FE Crown Fund Ratings are quantitative ratings ranging from one to five designed to help investors identify funds which have displayed superior performance in terms of stockpicking, consistency and risk control.

A single FE Crown Fund Rating reflects the lowest tier, and suggests the fund has failed to impress on the above terms, while a five FE Crown Fund Rating reflects the highest tier and identifies a fund which they think is of superior quality.

Ratings are not the only criteria that we use because some sectors, property for example, are anomalous.

Diversification between sectors, fund managers and asset classes will ensure that your portfolio performs as much as possible within the market and fulfil your financial objectives. But always remember that equity investment can always go up or down.

If you are interested in more information about Unit Trusts or ISAs contact Isis Financial Planners.