Using an Individual Savings Account as a long-term investment bolthole will become more important in coming months.
This is not just a result of continued poor savings rates making investments a compelling proposition.
It is because of an imminent reduction in the tax-free dividend income that investors can earn from shares or investment funds held outside an Isa.
Currently, up to £5,000 of dividends can be received in the financial year ending April 5 without tax being applied. But in the new financial year, this tax-free allowance will reduce to £2,000.
Investing: Using a stocks and shares Isa as a long-term bolthole will become more important in the coming months
For dividends above this limit, investors will be taxed at 7.5 per cent if they are basic rate taxpayers.
For higher and additional rate taxpayers, the tax is 32.5 per cent and 38.1 per cent. In contrast, any dividends received within an Isa wrapper will remain free of these charges.
The impact should not be underestimated. Someone receiving £6,000 of dividends a year will pay £225, £975 or £1,143 extra in the new financial year – depending on whether they are a basic, higher or additional rate taxpayer.
Investors facing this tax crunch, can mitigate the effect by moving shares or funds into an Isa through a process called ‘bed and Isa’.
The shares are sold, then bought back within the Isa. The investor’s annual £20,000 allowance is reduced by the cash equivalent of the sale of the shares.
There will also be charges levied, typically on the repurchase of the shares within the Isa wrapper.
But if it stops tax eroding future dividend receipts, ‘bed and Isa’ will prove a wise move.
Tips to invest this year – and pick up income
For those not in a position to ‘bed and Isa’, but who want to use spare cash to put money in an investment Isa in the current tax year or start of next, there are plenty of options available.
Below, five leading Isa experts explain what they plan to do – if anything – between now and April 5 and what they have already done this tax year.
Among them, Jason Hollands of Tilney Investment Management will be using ‘bed and Isa’ to ensure some of his long-term savings are not hit by the reduction in the annual dividend tax allowance.
Many of the experts have chosen overseas funds (investing in the Far East and Latin America) as their selections for this tax year.
But there remains a powerful case for picking shares or funds with an income bent, especially if the income – paid in the form of dividends – is automatically reinvested. This process is known as ‘accumulation’.
Research just released by fund management house Schroders shows the benefit of reinvesting dividends rather than taking them as income.
If someone had invested £1,000 in the FTSE 100 Index at the end of 1999 – a few months before the dotcom crash of March 2000 – and pocketed the dividends, their lump sum would have grown by just 1.1 per cent annually over the next 18 years.
But if the dividends from the same leading companies had been reinvested, the annual return would be to a more impressive 4.6 per cent.
Nick Kirrage is a fund manager at Schroders. He says: ‘Dividend reinvestment is one of the most powerful investment tools available.
‘As our research shows, the difference to the rate of return can be substantial. In an era where interest rates are so low, investors need to be aware of relatively simple investment techniques that can help build returns. Dividend reinvestment is one.’
Of course, investors must do their research and make sure the income-friendly companies they are investing in can afford to keep paying dividends on a sustainable basis.
The FTSE 100 stocks currently paying the highest dividends include oil giant BP, which yields 6.3 per cent, as well as Vodafone and tobacco firm Imperial Brands, which yield 6.5 per cent and 7 per cent respectively.
Other top payers include pharmaceutical firm GlaxoSmithKline, mining giant Rio Tinto and insurance company Phoenix Group.
Telecoms giant Vodafone, for example, has increased its dividends for 28 years running, while energy supplier SSE has raised its dividend for 26 consecutive years.
Adrian Lowcock is investment director at fund manager Architas. He says: ‘Securing an income is not as straightforward as just looking for companies with the highest yield.
‘Investors should consider whether the payout is sustainable, what the outlook for the business is and how likely it is to grow its dividend.’
From safe bet to bonkers ideas – where experts would invest
Alison Treharne – Shore Financial Planning
My Isa goes into our ‘adventurous’ portfolio via regular monthly savings. It is a collection of investment funds with some 60 per cent exposure to global equities, 29 per cent in UK equities and the rest in emerging markets.
Two ‘stand-out’ funds I love within the portfolio are First State Asia Focus and Schroder Asian Alpha Plus.
The long-term economic growth that this part of the world offers will put me – and my clients – in good stead. Short-term volatility does not concern me.
I am 48 and have at least a ten-year horizon so am comfortable being adventurous.
Brian Dennehy – FundExpert
I am like the chef who must be seen to eat his own cooking. So I am following our ‘Bonkers’ Isa strategy.
This volatile but highly profitable approach is popular with clients.
In a nutshell you buy today the top performing fund from across the funds universe – and then six months later you sell out and buy the then top performing fund – and so on.
FundExpert’s latest ‘Bonkers’ pick is Legg Mason IF Japan Equity Hedged and my Isa money went into it earlier this month.
Jason Hollands – Tilney Investment Management
For my children, aged eight and ten, I invest monthly into Foreign & Colonial Investment Trust.
I hope the Junior Isas will in time defray the expense of getting through university or on to the property ladder.
I have yet to use my Isa allowance this year – a result of a kitchen extension that has proved a big commitment.
But my wife and I have shares in an investment trust outside of an Isa that we have owned for more than 20 years.
We plan to sell these to invest in an Isa. With the annual dividend tax allowance about to be cut from £5,000 to £2,000, this makes sense.
Mark Dampier – Hargreaves Lansdown
My last major buy within my Isa was Aberdeen Standard European Logistics.
This is a new investment trust that buys into the warehousing that sits alongside our motorways – and is used to feed the country’s retailers with stock and fulfil online shopping orders.
The trust has an attractive dividend of 5 per cent, which I like. Indeed, it is especially nice in an Isa where it is tax-free.
The income I generate within my Isa allows me to redirect it into other holdings in my investment portfolio.
Juliet Schooling Latter – Chelsea Financial Services
My strategy is to invest half my Isa allowance early in the tax year, then buy on market dips.
This year I put £5,000 in both Goldman Sachs India Equity Portfolio and Aberdeen Latin American Equity.
Interest rates in Brazil have collapsed, and there has been a pick-up in economic growth. Reforms are taking place in Argentina while Mexico is coping well despite President Trump.
I invested the rest in T Rowe Price Global Focused Growth on February 8, a week after global market corrections.
Funds to invest in for income
Some 26 firms in the FTSE 100 have increased their dividend every year for the past decade – no mean feat when you consider that includes the 2008 financial crisis.
But picking top dividend-payers yourself can still be tricky. An alternative is to invest in a UK or global income fund that has a portfolio comprising dividend-friendly companies.
Lowcock likes Artemis Income, which invests in FTSE firms such as BP, Vodafone and Lloyds Bank. The fund has returned 48 per cent over the past five years and yields 3.9 per cent.
He also recommends the Schroder UK Alpha Income fund, which invests in Vodafone, GlaxoSmith-Kline and Rio Tinto, among others.
The fund has returned 36 per cent over the past five years and raised its dividend in eight of the past ten years. It yields almost 5 per cent.
Finally, Lowcock tips Fidelity Moneybuilder Dividend, which has returned 32 per cent over the past five years and yields 5 per cent. It holds big consumer-oriented firms such as Unilever, which makes Persil, and Imperial Brands.
All of Lowcock’s selections are income funds. Income-oriented investment trusts are also worthy of inclusion in an Isa because of their ability to smooth the dividends paid to shareholders.
According to the Association of Investment Companies, there are 21 investment trusts that have increased their dividends for more than 20 consecutive years.
They include both global (Alliance, Foreign & Colonial and The Bankers) and UK invested trusts (JPMorgan Claverhouse, Murray Income and The City of London). A full list is available here on This is Money.
Investment platforms for easy stocks and shares Isa investing
The cheapest DIY investing platform depends on your investing plans, but for a starter stocks and shares Isa it may be best to go one that is easy to use and gives you a helping hand, writes Simon Lambert.
I’ve road tested these platforms and they deliver on those criteria.
With all of them the cheapest and easiest way to start investing will be in funds, which can be free or cheap to buy and sell.
My suggestions are Hargreaves Lansdown, AJ Bell YouInvest, Interactive Investor and Vanguard.
All offer best funds lists and/or ready-made portfolios.
Hargreaves Lansdown scores highly on being intuitive and easy to use. Finding and investing in funds is simple, as is setting up regular investments and checking up on what you have done. Its app is also very good. It’s not cheap, with a 0.45% annual fee but on smaller investment pots percentage charges should not be too high. Fund dealing is free.
AJ Bell is a more pared back experience but still simple to use. It has simple passive portfolios, a good best fund-finding tool and a cheaper 0.25% annual fee. Fund dealing costs £1.50.
Interactive Investor has a different charging model and costs £22.50 a quarter or £90 a year. That fee is given back in free trading credits, which you can use to pay to buy funds, shares, trusts and ETFs. The standard charge to buy or sell all those is £10, or £1 if you set up regular monthly investing. Interactive Investor is simple to use, and has good model portfolios.
A final more restrictive but simple and cheap option is Vanguard. The US giant has set up a UK investing platform but you can only buy its funds. It is cheap with a 0.15% per year fee and has no costs for buying and selling. You can use this to buy Vanguard’s simple and cheap passive funds, or its all in one LifeStrategy funds that invest in shares and bonds around the world.