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What is a stocks and shares ISA?

By:  Peter Stephens | 3rd March 2022

Reviewed By: Sean LaPointe on 7th October 2021

As a long-time writer for The Motley Fool, I love investing. And if there’s anything I love more than investing, it’s investing with tax advantages! And that’s what’s great about a stocks and shares ISA.

If you are wondering what a stocks and shares ISA is and how it works, here is everything you need to know.

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What is a stocks and shares ISA?

A stocks and share ISA is basically a tax wrapper that can be put around a wide range of investments. Any capital gains, dividends or interest received from investments in a stocks and shares ISA is tax-free.

As you’d expect for a financial product, there are some conditions to be eligible. Notably, you must be a UK resident (for tax purposes) and be aged at least 18.

How does a stocks and shares ISA work?

With a stocks and shares ISA, you can buy and build a portfolio of different investments including shares, corporate and government bonds, exchange-traded funds (ETFs), investment trusts and many others.

Most of these can also be bought using a regular share-dealing account. The main difference with a stocks and shares ISA, however, is that it comes with tax efficiency. As previously stated, investments held within a stocks and shares ISA are exempt from capital gains tax, dividend tax, and income tax. This could mean a significant amount of tax savings during the course of a lifetime.

For example, imagine if you bought shares in a company for £5,000 and sold them later for £20,000. Normally, there would be £3,000 of capital gains subject to tax (after the £12,000 annual allowance is deducted). This would be taxed at either 10% or 20% depending on whether you are a basic-rate or higher-rate taxpayer. But if those shares were held in a stocks and shares ISA, you wouldn’t be subject to that tax. In this case, a basic-rate taxpayer would save £300, while a higher-rate taxpayer would save £500.

Turning to dividends, the annual allowance for dividends received outside of a stocks and shares ISA is £2,000. Someone who has an annual dividend income of £20,000 would be taxed at 7.5% or 32.5%, again depending on whether they are a basic-rate or higher-rate taxpayer. That would mean £1,350 in taxes for the basic-rate payer and £5,850 for the higher-rate payer. But, once again, an investor using a stocks and shares ISA would be saved this hefty tax bill.

These tax savings are indeed a key reason why many investors open a stocks and shares ISA instead of (or in addition to!) a regular online share-dealing account.

What is the stocks and shares ISA allowance for 2021-2022?

Since there are tax advantages involved, it’s probably not too surprising to hear that there are limits to how much you can invest in a stocks and shares ISA. The maximum amount that can be invested in one of these accounts each tax year is £20,000.

It’s also important to note that this annual allowance is a cumulative figure across all types of ISAs. So if you go ahead and invest the full £20,000 in a stocks and shares ISA, you wouldn’t be able to invest in a cash ISA, innovative ISA or other types of ISA.

Likewise, it is not possible to repay amounts that are withdrawn from a stocks and shares ISA, unless the payments form part of the annual allowance. Which means that if you pull £1,000 from your account, you can still only put £20,000 into it during the tax year (not £21,000).

How risky are stocks and shares ISAs?

Some of the assets that you can hold within an ISA, e.g. shares, can go up and down – putting your capital at risk. As a result, a stocks and shares ISA is generally viewed as a riskier proposition than other types of ISA, like a cash ISA.

However, over the long run, investments such as FTSE 100 shares have historically risen. In fact, the FTSE 100 index has posted annualised total returns (that is, capital growth plus dividends received) in the high-single digits over the long run.

As such, investing in a range of shares has the potential to grow your savings while capitalising on the tax efficiency offered by a stocks and shares ISA.

What types of fees are in a stocks and shares ISA?

The fees on a stocks and shares ISA will vary according to your chosen provider. Different providers have not only different types of fees but also have different fee structures.

Further, the total fees you pay may depend on different factors, such as:

Here are the most common fees to expect when investing in a stocks and shares ISA.

Platform fee

This is basically the admin fee that you will have to pay your ISA provider to cover the running costs of your ISA. Usually, it will be an annual fee calculated as a percentage of your total ISA holdings. That means that the larger your investments, the higher the platform fee.

Some platforms, however, use a tiered basis to calculate your platform fee whereby you pay a lower fee for bigger investments.

Other providers may also charge you a flat fee. This is where you pay a set sum every month or year (regardless of the amount invested to cover the cost of running your ISA). A flat-fee structure could turn out to be cheaper for people with relatively large ISA holdings.

Annual management fee

This is the fee that your provider will charge you to manage your portfolio. Essentially, it is the ongoing cost of looking after and fine-tuning your investments on your behalf to ensure they remain on track. The fee can vary significantly between different providers.

Of course, if you choose a DIY approach – that is, if you select and manage your own investments – you won’t have to pay this fee.

Dealing charges

This is a charge that is levied by your provider whenever you trade a stock. If you are a buy-and-hold investor, this charge likely won’t matter much. However, if you are a frequent trader, finding a platform with low dealing fees should be a top priority. Most platforms will charge you a fixed fee per trade based on the number of monthly trades you execute.

Some providers, however, don’t levy a dealing fee and may instead factor the costs into other charges such as the platform fee.

Transfer fee

An ISA transfer fee is the fee associated with moving or switching your stocks and shares ISA from one provider to another. It is also known as exit fees.

The costs vary from provider to provider, with some companies not levying any charge when you decide to move on from them.

Account closure fee

You may have to pay a fee to close your account completely with a provider. Once again, whether you will have to pay this fee, as well as the amount, will vary between providers.

As the fees and costs of opening and managing an ISA can vary significantly between different providers, it is worth shopping around to find the best deal.

Overall, though, the cost of having a stocks and shares ISA versus a share-dealing account is often fairly insignificant when the tax benefits of the former are factored in.

If you are thinking of investing in the stock market or in another mainstream asset such as bonds, a stocks and shares ISA is definitely worth keeping in mind.

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How to open a stocks and shares ISA

Stocks and shares ISAs are available from a wide range of providers, including banks and building societies, stockbrokers, and fund management companies.

The easiest and often the cheapest way to open a stocks and shares ISA, however, is through online investment platforms. There are many online investment platforms in the UK, each with advantages and disadvantages.

Our top-rated stocks and shares ISAs can help you find the best deal or platform for your own personal circumstances.

Once you’ve picked a platform, the next step is to decide what types of investments to hold.

If you don’t want the hassle of picking investments yourself, the good news is that you can actually open a stocks and shares ISA with a ready-made portfolio. Here, an investment manager or ‘robo-adviser’ picks and manages investments for you based on your investment goals and risk-profile.

Worth noting is that you can only pay into one stocks and shares ISA each year. However, you can open a new ISA with a different provider each year if you like.

Once you open a stocks and shares ISA, you can choose to make a lump-sum investment into the account or you can make periodic contributions throughout the year.

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