A month into the new tax year, savers must decide whether to open a cash Isa or take the gamble in an investment Isa. Dennis Hall (right), managing director of adviser firm Yellowtail Financial Planning, explores your options.
It's the beginning of a new tax year and you face a dilemma.
Do you top up or start your tax-free cash Isa or ignore cash and invest immediately in your stocks and shares Isa, which gives tax breaks?
While it's a straightforward question, the answer is anything but simple (see the MSE Isa Guide which explains the tax benefits).
Whether you are rich or have more modest means, the Isa has a place in your savings and investment portfolio. So how do you decide?
Initially, you should ignore the tax advantages of the Isa and ask yourself what the money is for.
Many bad savings and investment decisions are made because the focus is on the tax savings above all else.
Keep cash aside
You are likely to have a mixture of short and medium term cash requirements.
Once these have been secured you can move to longer-term investments that may include shares and other higher risk assets.
If you have not yet saved enough cash to take care of your short-term needs, then this should be your priority.
You should consider having six to 12 months of expenditure as an emergency fund in case of unemployment or severe illness.
Short or medium term savings needs, such as a house deposit, also require cash savings, and the cash Isa is ideal for this. We will all have different cash requirements, and these should be secured first.
If you have any cash savings that are not yet sheltered in an Isa tax wrapper you should immediately take steps to rectify this and move them to an Isa.
Miserly interest rates on offer mean your savings need all the tax breaks they can get.
Benefit of stocks and shares
Once the short term needs have been taken care of, your thoughts will turn to longer-term savings.
This will probably include shares and may be held individually or through funds. Depending on the amount of risk you are willing to take (and other factors) you may also invest in government and corporate bonds.
I'm going to deal with shares first.
For many investors, unless they have a sizeable portfolio of investments already, an Isa isn't going to have much of an impact in the early years.
Unless you are already using your annual capital gains tax allowance (where the first £10,600 of gains a year are tax-free) then there is no immediate benefit in having a shares Isa.
Similarly, unless you are a higher rate taxpayer, the tax treatment of the dividends payable from your shares is the same as non-Isa investments.
However, after several years of saving the portfolio will increase and the tax breaks of the Isa become more apparent.
What's it to be? Cash or shares?
For many, cash Isas are likely to give a more immediate tax saving.
The same is true for Isas invested in government or corporate bonds. The dividends from these bonds are treated as interest, not share dividends.
That means all the tax paid on the interest is returned when held in an Isa, so is tax-free.
As a planning point, when dealing with portfolios that have shares and bonds I tend to put the bond part of a portfolio in the Isa for a better income tax saving.
Remember, your short, medium and long term needs should dictate your investment strategy, not the tax wrapper.
Views expressed do not necessarily reflect those of MoneySavingExpert.com.