How to choose this year’s equity Isa

ISA sales reached an eight year high in 2009 at £2.8bn, reversing a trend of net outflows from the sector, according to the latest figures from the Investment Management Association.

This is compared to the previous five years which have all ended in net outflows from Isas, with £1.6bn leaving accounts at its peak in 2008.

But the question on investors minds at the moment will be where to put their equity Isa money this year. If you’re over 50 then you can invest a total of £10,200 and if you’re not you can still put up to £7,200 in equities or funds.

Simon Marsh, partner at Killik & Co, answered readers’ questions on the rules surrounding equity Isas and which ones to choose depending on how risk adverse a person is.

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What sort of income could I get for me and my wife if we each invested the increased Isa allowance of £10,200 for the next twenty years, Ben Nath, London

SM: If you invested £20,400 (£10,200 each) pa and assuming a real rate of return of 4 per cent after inflation this could generate a fund value of over £300,000 each (or £600,000 in total), which in turn could generate an income of £30,000 (5 per cent) tax- free.

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Which are the best global equity income funds that give the best income, with some growth and medium risk? Gillie Baerselman, Guildford, Surrey

SM: High income funds tend to focus on cash generative companies such as Glaxo, Vodafone, Roche, BP among others. As these funds are still invested they can be volatile, so your capital value is still at risk. However, one fund of particular interest is Veritas Global Equity Income which has a prospective yield of 5 per cent managed by Charles Richardson and Andrew Headley. This fund employs a global thematic and unconstrained investment approach with the ability to hold up to 25 per cent in cash if no suitable opportunities are available.

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Will any interest I receive on cash held in my Stocks & Shares ISA be paid gross? Tony Ching, London

SM: No. Unlike Cash Isas, any interest received on cash held within a Stocks & Shares Isa is subject to a 20 per cent flat rate charge levied by HMRC.

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I’m interested in putting my money into ethical stocks and shares. Can I do this with an equity Isa? Which one would you recommend? Henry Holland, Kent

SM: With investment Isas you can choose individual equities or funds to suit your own personal ethical views and requirements. However, be aware that Isas cannot hold the smaller AIM listed companies, thus only leaving them larger companies to invest in. There are also ethical funds so you can decide how ’green’ you want to be.

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I’m 35 years old and want to save money into a stocks and shares Isa rather than paying money into a pension. Which Isa should I be looking at for long term growth? Kate Coral, Leeds

SM: You should ideally be looking to put your money into an investment ISA. As you are young and your time horizon is a long one could probably take on more risk therefore investing a higher percentage in equities. We suggest looking at a broad range of funds including those from UK and the emerging markets the key is diversification. Killik & Co provide an Isa which has no charge for the wrapper but allows you access to a very wide range of investments.

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Why is it better to hold money in an equity Isa than just invest it in a fund? Do I still get taxed on dividends or does holding it in an Isa avoid this? Anna Green, Herts

SM: Holding funds in Isas avoids any capital gains tax on gains; further to this you will not be taxed on dividends other than the 10 per cent withholding tax, this is particularly beneficial for higher rate tax payers. Most important of any income you take is free of income tax - this is not the case with stand alone funds.

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Aside from shares, can I hold corporate bonds and government bonds in my Isa account? Stuart Ross, London

SM: Yes. You can either hold such bonds through a bond fund (which invests in a range of bonds), or individually. However, the rules that govern Isas do stipulate that the individual bond must have at least 5 years to run until its redemption date.

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I would like to ask Simon Marsh if he is using his Isa allowance this year, and where he is planning to invest this money? Ben Smith, London

SM: I have invested in Statoil. Of all the oil majors Statoil is one of the most geared to a continued rise in the price of oil/gas given its focus on up stream activities. My own view is that the oil price could move considerably higher over the next few years.

The dividend has increased to 6NOK and there is a promise to grow this in line with future earnings.

It is worth pointing out that Norway is the only country in Europe running a budget surplus and given the current turmoil in currency markets NOK’s should provide a safe haven for UK investors. No guarantees that I’ve got it right!

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I need to transfer from one provider to another but I keep reading horror stories of money going missing, and transfers taking anything up to three months. Why should this happen, and what can one do if it happens to you? anon

SM: Responsibility for the transfer normally lies with the existing plan manager. The new plan manager, who is receiving the funds will always be keen to get the assets under their control as soon as possible. In the event that your transfer is taking longer than the standard 30 days stipulated by HMRC in their Isa rules do talk to your new plan manager and they will chase the old manager for updates.

I am not aware of money going missing but if this happens speak to your new manager and they will get the old manager to trace where they have sent the money too.

When transferring your investment Isa do ask if your new Isa provider if they will pay the transfer fees, some providers such as Killik & Co do but other do not.

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If I subscribe £2,000 to a Cash ISA this tax year, am I correct in saying I can only put 3,600 in a Stocks & Shares ISA? Clair Baldry, Brighton

SM: No. Assuming you are currently under 50 years of age, your overall ISA allowance for this current tax year is £7,200. You can subscribe up to £3,600 of this in a Cash ISA with the remainder of the allowance available for a Stocks & Shares Isa. Therefore, in your case, you would still be able to subscribe up to £5,200 into a Stocks & Shares Isa this tax year. If you are currently over 50 years of age, then the amount available for you to subscribe to a Stocks & Shares Isa would increase further still to £8,200.

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I will be able to invest £10,200 in an Isa this April and already have about £15,000 in Isas in a range of banks/building societies. Do you advise putting them all together in one account - how do I decide - or spreading them around. I would like some of it to be available for withdrawal if necessary (about £3000) Margaret Day, Midlands

SM: For cash Isas it may be worth shopping around as some banks and building societies offer better rates for larger sums. As for the investment element, one provider may be enough but I would suggest looking to invest in funds for better diversification. If you need cash available, it would be wise to hold a cash ISA as well as an investment Isa so that there is always cash available to you. If you are thinking about consolidating your Isa holdings some companies, including Killik & Co, offer a free ISA review service to help decide whether to remain with the status quo or change provider. The key thing is to take control of your investments and annually check past performance, fees and that asset allocation continues to meet your needs. Consolidation does have the advantage of transparency and it is easier to track how your investments are performing.

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I am in my mid 30’s and have about £5,000 to invest in an Isa before the expiry date this year. What are the best options. Why is an Isa a good investment? When is the deadline for investing in an Isa this year. Thanks, Sase Singh, UK

SM: If you have £5,000 to invest you have two options; either to invest part cash (with a maximum of £3,000 this tax year) with the rest in investments or you can put the whole £5,000 into an investment Isa.

Cash Isa’s are a good investment because you avoid paying tax on interest. With an investment Isa you avoid paying Capital Gains Tax and having to pay tax on the income received. Therefore your overall return could be increased by up to 40 per cent without taking any additional risk, other than the risk of the underlying investment. However, it must be noted that you are no longer allowed to reclaim the 10 per centwithholding tax on dividends.

The deadline for investing in an Isa is the end of the tax year; Monday 5th of April. However, be aware that it is also Easter Monday this year so make sure you do not miss out by planning ahead.

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Hi, I have a few questions on equity Isas. 1. Where will I invest in 2010 please? UK; US; Europe; Japan; Latin America; China; Emerging markets? 2. What funds should I invest in for 2010? 3. Could you tell me Investment ideas for regular savings in a Stocks & Shares ISA and SIPP please? Regards, Emma, Bristol

SM: 1. In the UK many of the factors that have driven the equity markets higher in 2009 will remain in place over 2010 (i.e. loose monetary policy, low yields on cash and government bonds, attractive valuations and cash on the sidelines waiting to be invested). Having said that, given the growth within the UK economy overall is likely to be subdued, it is more important than ever to make sure that you are not over-exposed to UK centric businesses. The global economy is recovering well, aiding growth in the BRIC economies in particular (Brazil, India and China)

2. In particular, we would highlight technology and emerging market funds as areas likely to experience superior growth. Funds that have good exposure to higher earnings growth include Polar Capital Technology Investment Trust and Lazard Emerging Markets.

Strong companies are well placed to take market share from rivals that have either gone out of business or are too financially stretched to take advantage of attractive growth opportunities. The funds we believe have a greater than average exposure to well-capitalised businesses that are positioned to take market share include M&G Global Basics, Findlay Park American Smaller Companies and First State Asia Pacific Leaders. Funds that offer a yield above that of cash and bonds and good prospects for long-term capital growth include First State Asian Equity Plus, Invesco Perpetual Income and Veritas Global Income.

3. The vast majority of investment funds can take contribution on a monthly basis. This is a good way of smoothing out highs and lows of market volatility, particularly for higher risk investments such as emerging markets funds.

Please listen to Killik & Co’s latest podcast highlighting some of key investment themes for the coming months .

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As a 50 year higher rate tax payer, would I be better off paying £10,200 into my ISA or my pension? Brad Jensen, London

SM: The first question when making this decision between an Isa or pension is to ask yourself whether you are likely to need the money before retirement. If you are, then it would probably be sensible to invest in the Isa. If you do choose to invest the money in an Isa and take the income at retirement, it will not have any impact on the age-related tax allowances because income from Isas is not taxable, unlike income from pensions taxed at your marginal rate.

Depending on your earnings you can choose to cash in your Isa and contribute it in to your pension closer to retirement. Making a pension contribution when you are a higher rate tax payer is also attractive as you may be able to receive 40 per cent relief on your contributions. If £10,200 is your annual contribution to a pension and you are paying a higher rate tax on this, it is classed as a net contribution. You will receive an addition £2,550 into your pension by way of basic rate relief. You can then claim a further £2,550 back via your self assessment. This will mean that the £12,750 in your pension pot has only really cost you £7,650. If you were then to retire and take your tax free lump sum of 25% (£3,187.50) you will be left with £9,562.50 in your pension pot which has only cost you a total of £4,462.50. In conclusion, it would be more tax efficient to pay the money into a pension rather than an ISA provided that you are happy to tie the money up.

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If I understand correctly, the totally tax-free status of growth in the stocks and shares ISA has already been compromised by a tax levy on dividends of 10 per cent. As a result, the correct terminology is now ’tax-free’ growth in the cash Isa, but only ’tax-advantaged’ growth in the stocks and shares ISA. How can we be sure the government will not take similar actions in future, as it looks for additional revenue streams? John Doherty, Derry, Northern Ireland

SM: In the 2006 pre budget report Gordon Brown announced that ISAs will be a ’permanent fixture of the investment landscape’. It is true that you are no longer allowed to claim back the 10% withholding tax levied on dividends, however the limit for over 50’s was increased this year to £10,200 and will increase for the rest of us on April 6th showing the government’s commitment to this type of tax advantaged wrapper.

The biggest plus with ISAs is that the income is tax free. It would be a brave government which would reverse this (That is not to say it wouldn’t happen!).

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Dear Sir, A lot has been forewarned about the risks of holding onto corporate bond funds following the sharp rally in 2009 and the likely increase in government bond yields this year.

Will strategic bond funds carry the same risk (I.e. A capital loss) or are they still a good investment for those wanting a solid core to their portfolios (I.e. A circa 5 per cent return per annum)?

If they are still a good investment in the current conditions, what allocation would you recommend for a medium risk investor who has a medium term time horizon?

If not, what alternatives to strategic bond funds would you recommend and what percentage would you recommend allocating?

Kind regards, George Playle

SM: During 2009 we have seen a significant increase the capital value of corporate bonds and corporate bond funds, this is due to falling interest rates and quantitative easing the flip side of increased capital value is that the yield decreases. Corporate bond funds can be a great source of income, but if yields do increase we are likely to see a decrease in the value of their capital if interest rates rise to 5% you could find it difficult to sell out during this time.

Strategic corporate bond funds such as L&G’s Dynamic Bond Fund have the ability to benefit from a falling market so could help maintain its capital value while still generating a healthy income.

If you have a large enough portfolio our preference would be to invest in direct corporate bonds, that way if interest rates do increase and the capital value falls you will at least know when it will increase again to par value at its redemption date.

For a medium risk medium term portfolio we would invest up to 50% in non equity, the majority of this would be corporate bonds and bond funds. However this would depend on the age of the investor, medium risk for an investor in their twenties would have far fewer bonds than a medium risk investor in their seventies for example. The other non equity investments we would consider included absolute return funds such as Mark Lyttleton’s Blackrock Absolute Alpha.

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