Stocks and shares ISAs explained
A stocks and shares ISA acts as a tax-free wrapper for stock market investments but despite its advantages (particularly for higher rate tax payers) it’s also a complex product that involves an element of risk, meaning that the value of your investment can go down as well as up. In this part of our ISA guide we explain how stocks and shares ISAs work in more detail.
The key facts about stocks and shares ISAs
Eligibility
To open a stocks and shares ISA you must be a UK resident (or a Crown employee serving overseas, or the spouse of such an employee); and be aged 18 or over. When you open a stocks and shares ISA you’ll be required to provide a form of ID, such as a passport or driving licence, along with you National Insurance number. You can only open a stocks and shares ISA with one provider each tax year, although you can have different stocks and shares ISAs with different providers in different years. Essentially this means that you can’t split your annual allowance between different providers.
Stocks and shares ISA allowance
The stocks and shares ISA allowance for the current year (2012/2013) is a maximum of £11,280, dependent on whether investment is also made in a cash ISA. If the full cash ISA allowance is used then the maximum investment in a stocks and shares ISA is limited to £5,640.
Investment options
A variety of non-cash assets can be invested in a stocks and shares ISA, including:
- Gilts and bonds
- Individual shares and corporate bonds issued by companies officially listed on a (global) recognised stock exchange.
- Unit trusts, investment trusts and open-ended investment companies (OEICS).
- Exchange traded funds.
When you invest in a stocks and shares ISA you can also choose between a ’self-select ISA’ and ’collective investments’ – we explain these in more detail later.
Risk profile
Due to the wide choice of investment options the risk profile of a stocks and shares ISA can vary from very low to very high and everything in between. The type of stocks and shares ISA that's right for you will depend on your personal circumstances, what you want to achieve from the investment and your overall attitude to risk.
Withdrawls
If you withdraw money from a stocks and shares ISA during the year you cannot re-invest at a later date with the intention of topping the balance up. This is because you can only invest up to the ISA allowance for that tax year, regardless of how many withdrawals you make.
Income received
When you receive income from your investment it will be treated in the same way as a withdrawal therefore if you do want to increase your capital investment you may wish to consider an income re-investment option which automatically adds your income to your capital.
Costs and charges
The cost of a stocks and shares ISA depends on where you buy it and what you choose to invest in it. Most stocks and shares ISAs have initial and annual management charges; the former can range from 0.5%-5.5% and the latter from 0.5-2%. The charges are typically used to cover admin costs and to pay fund managers.
What is a self-select ISA?
A self-select ISA will give you full control over your investments, allowing you to choose which shares you invest in. Usually a self-select ISA will be managed by a stockbroker on your behalf, although the element of risk can be high if your investment lies with just a handful of companies.
What are collective investments?
Collective investments are the most common use for stocks and shares ISAs and are extremely popular with first time or inexperienced investors. With this type of investment your money is pooled with that of other investors and placed in a wide range of shares that match specific criteria. The advantage is that should a couple of companies in the portfolio make a loss, there are others to compensate.
Collective investments fall into four main categories, these being:
Tracker funds
Tracker funds invest in all the companies in any given index (e.g. FTSE 100 or 250) according to their market weightings. They are designed to maximise returns by minimising costs and are the cheapest way to spread equity investments.
Equity income funds
With this type of investment fund managers use your money to invest in companies that they consider will offer consistently high returns.
Fund of funds
Rather than investing in shares, Fund of Fund (FOF) managers invest in other types of funds on your behalf by utilising the expertise of other fund managers. On the plus side, you are less reliant on one asset and are able to minimise your risk; on the downside this type of investment can be costly.
Balanced managed funds
In principle balanced managed funds are similar to fund of fund investments but with a restricted maximum equity exposure of 85%. The main benefit is that the amount of money you can lose is restricted as the remaining 15% is held back, but on the downside it also places a cap on the amount of money you can make.
How do I switch a stocks and shares ISA?
You can transfer a stocks and shares ISA to another stocks and shares ISA at any time however you must transfer the funds and not close your account with the intention of opening a new one. Any funds that are withdrawn will lose their tax-free status.
Your new ISA manager can arrange a transfer for you but depending on the terms and conditions of your current product you may be required to pay a charge or sell any existing investments and transfer the cash equivalent instead.
When you transfer a stocks and shares ISA remember that:
- You cannot transfer it to a cash ISA.
- The current year’s ISA balance must be transferred whole and cannot be split between providers.
- Any previous years’ ISA balances can be split between different providers, subject to the terms of the accounts in question.
Do I need independent financial advice?
Due to the nature of stocks and shares ISAs and the element of risk involved you may wish to seek independent financial advice before investing, particularly if you are a first time or inexperienced investor. Independent Financial Advisers (IFAs) are authorised by the Financial Services Authority (FSA) and specialise in these types of investments; as such they can help you to maximise your returns without exceeding the level of risk you are comfortable with.
Remember! With a stocks and shares ISA the value of your investments and the income from them can go down as well as up. You may not get back the full amount you have invested. If you’re in any doubt you should consult an appropriate Financial Adviser.
In the final part of our guide we look at the differences between cash ISAs and stocks and shares ISAs so you can make an informed choice about which ISA is right for you.
back to top
« Cash ISAs explained
Comparing ISAs and ISA rule changes »
