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Tax and Tax Free Investments

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General Tax tips.

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      19.02.2002 23:43
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      Here I am sitting in my writing shed. You see, I don't type out my opinions, I paste them together with bits of old stories and a little paper glue. I'm a sort of Roald Dahl but without the talent. I've been scratching around trying to come up with my latest tale of the unexpected. Rather fiendishly, I've concocted a terrible story of the tax year-end looming and a wanton waist of individual tax allowances. Allow me to tell you more… ***Charlie and The Tax Factory*** Charlie is one of several groups that should avoid paying tax on the interest on their savings. He falls into the student grouping but others should be weary too. These include pensioners, homemakers and children. Basically anyone that is unlikely to earn more than his or her £4535 annual allowance (subject to review by the Chancellor when working out his budget) Avoiding paying tax on your interest is easy. Merely, self-certify on a form R85 available from Banks, Building Societies, Post Office etc. Once completed and handed in, they should do the rest for you. Those with children should note that kiddies can earn up to £100 in interest before becoming eligible to pay tax on it. However, only parent or guardians can sign the form on behalf of minors so grandparents and friends opening these sorts of accounts on behalf of little ones would need to get them signed by the appropriate person. Those with non-taxpaying partners should consider transferring funds into the non-taxpayer's name to avoid being taxed on the interest. Self-employed folks should make sure they claim all allowances available to them (see Inland Revenue for help at inlandrevenue.gov.uk or check it out with your accountant) and endeavour to avoid giving the IR windfalls in the form of penalties for late submission of tax returns. ***James and His Giant Annual Tax Free Allowance*** Having disposed of his peach, James is left wanting to build up a nest egg to
      replace the giant fruit. As he’s now over 18 he is entitled to his full £7000 tax-free savings allowance. The present government decided to replace the previous TESSA (Tax Exempt Special Savings Account) with *ISA. I won’t bore you with the ins and outs of TESSA, as you can’t open new ones but concentrate on ISA instead. ISA stands for Individual Savings Account and were meant to encourage small savers to save more regularly. Things haven’t quite worked out that way and whilst supermarkets did show an interest in handling these sorts of investments initially, interest has now waned and the traditional providers such as banks and building societies have become the main stay once more. Each tax year, those over 18 have a tax-free allowance of £7000. This can be split in a number of different ways and can be a little confusing. At this stage we can bring in some mini case studies. *** Willy Wonker's Cash ISA** Willy Wonker is totally risk averse and hates the thought of shares. He wants a guaranteed situation where he will get his money (capital) back. He can opt to invest a maximum of £3000 into a cash ISA that, in reality, just amounts to a passbook investment. There is no set term for which he would need to leave his money. He may need to give 7 days notice for withdrawals depending on the provider. Also, he may not necessarily get a passbook. It depends on which institution he chooses as a provider. He can only have one cash ISA from any given source in any tax year. However, he is free to use another provider when entering a subsequent tax year. If he decides to invest between £1 - £3000 then this is called a mini-ISA regardless of type of investment i.e. cash or shares. If he decides to invest the full £7000 then this is called a maxi ISA. Those either 16 or 17 years old can only open cash ISAs subject to a £3000 limit. ***Aunt Spiker's Stocks and Shares*** Str
      ictly for over 18’s only. Aunt Spiker has escaped incarceration and is willing to take a risk. She wants to invest for growth. She can invest her full £7000 limit in a stocks and shares ISA if she wants. For beginners, the tracker funds are a good idea. These pool investor’s money and spread the risk over a large range of shares. Most will track the top 100 companies, as these are invariably blue chip, household names like Marks & Spencer's and Barclays Bank. However, Aunt Spiker is not sure (a) what a share is and (b) what will happen on the stock market. (a) A share is a stake in a company. When an organisation starts up it needs to raise money to finance the operation. Usually, it will issue a finite number of shares for which investors pay money in exchange. The investors hope that the value of their shares will increase over time by the value of the company increasing. This can be achieved through a variety of means but most common is to declare annual profits, which would usually mean that the company is getting bigger (b) Secondly, as a reward to their shareholders, the company will ring fence some of the profit and return it to their investors in cash form. This is called a dividend. The share price is dependant on all sorts of factors, which are outside the scope of this opinion. Suffice to say that it is possible to check the share price daily either in most newspapers, various websites (e.g. bbc.co.uk) or even Teletext (try. page 520 channel 4) The stock market has suffered over the last 2 years. According to Credit Suisse First Boston the value of equities (shares) fell 13.2% last year. Prior to that the fall was 8.6%. However, history suggests that negative returns for a third year running are extremely unlikely. Moreover, a viewpoint of 3-5years should be taken when considering any form of share investment. This allows time for the investment to recover from troughs. In virtually every 5-year
      period since the war, the stock market has shown a positive gain on the whole and the returns far outstrip standard deposit based investments. ***How much is this going to cost Aunt Spiker as she wants to save for her Revenge Fund?*** She has 2 options: to contribute monthly or via lump sum. Monthly contributions can, typically, be anything from £20 - £50 minimum depending on the provider. Lump sums tend to be in units of £500. Each have their own merits. If she chooses the lump sum option then she will take advantage of a rising market as the maximum amount invested is exposed and profits more than if a monthly contribution. Conversely, if the stock market dips then she will take a bigger hit. A monthly contribution irons out the peaks and troughs in the market and is more advisable for the less experienced. After all, it can be a real rollercoster if you decide to check the progress daily and the market takes a downturn. ***Why is this a better long term option?*** Inflation is currently around 2.6%. This means that your money has to grow at around 3.1% (allowing for tax) just to break even. Deposit accounts will rarely pay much more than this over the long term so Aunt Spiker's money is hardly likely to grow at all. **Historically, the stock market far outperforms deposit investments. The Pound - Cost Averaging Theory, can encapsulate it: Bearing in mind that funds are generally split into units and investors buy units with each premium. If £50 is invested in a share related product (e.g. tracker fund) and the unit price is £1 per unit then 50 units is bought. If the price of the unit remained constant throughout the year then, assuming a monthly contribution of £50, then 600 units are bought in the year and the value of the fund is £600. However, if after 3 months the price reduces to 50p (there's a scarcity of peaches resulting in a run on the peaches fund) and the price stays at 50p for
      a further 3 months then the number of units bought whilst the price is 50p is 300 i.e. monthly premium of £50 buys 100 units at 50p per unit for 3 months. The price recovers to £1 again for the final 6 months so a further 300 units are bought (£50 at £1 per unit x 6 months). So, at the end of the year, Aunt Spiker now owns 750 units quoted at £1 per unit i.e. the value of the fund is £750 and worth £150 more than if the price had remained constant. This is the basic tenet of stocks are shares products and why peaks and troughs are encouraged. To ensure a loss isn't made (which can only happen if Aunt Spiker sells at the wrong time) a time frame of 3 – 5 years is advisable to allow the product time to take advantage of Pound – Cost Averaging. The product will usually attract a charge, commonly 1% annually. Dividends are usually re-invested to assist the growth of the fund. Some may allow part withdrawals during the 5-year time frame. ***So where should Aunt Spiker purchase her tracker product?*** Tracker funds are a very competitive market. There are outlets on the web that will make these available including renowned names like Virgin, Legal & General, Nationwide, and Halifax etc. She can try Money.Xtra.com for one but she can go directly to the organisation's mentioned e.g. Halifax.co.uk etc You can organise the product over the web and avoid paying for advice, which would be incurred through face-to-face or telephone dealing. ***What if I'm more sophisticated?*** You could try a G & T or alternatively try stocks and shares directly or even self-select funds. Aunt Sponge is experienced in the stock market and even has her own share dealing web account at Charlesschwab.com. This enables her to deal over the Net and keep her costs down. She can organise her own Maxi ISA (i.e. £7000 invested) and choose how the funds are invested. She needs to remember that she should only invest those fund
      s that she can afford to lose with these sorts of investments as they are more speculative and the corresponding risk is higher. So there you have it. I hope my latest tale has made things a bit clearer for those entering the world of tax free investments and a little general tax advice thrown in there as well. How am I doing Sue? Note £1000 is allowed to be invested in a life assurance ISA but I don't know of any companies offering this due to total lack of interest. *The cats from The Witches wanted to add that the Government came up with their indicator of quality for ISA products as a benchmark for the public. These are called CAT standards and stand for cost, access and terms. Generally, if the product complies then it is a fair indicator of quality although NOT a seal of approval from the government. For cash ISA: Charges - No one-off or regular charges of any kind. This means no charge for withdrawals or for any regular service. Access - Minimum transaction size to be no greater than £10 and withdrawals within seven working days or less. Terms - Interest rate to be no lower than two percentage points below the base rate (the rate published by the Bank of England in connection with its open market operations). Any upward interest rate changes must reflect base rate movements within a calendar month. Downward changes may be slower. No other condition may be imposed such as limits on frequency of withdrawals. For Tracker ISA: Charges - Annual charge should be no more than 1%. Access - Minimum savings limit can be no higher than £500 for a lump sum investment. Terms - Units in a unit trust have to have the same price whether you are a buyer or seller. **Whilst the past is not necessarily a guide to future performance an example of relative stock market performance is: Based on the growth of the FTSE 100 index over the last fiv
      e years (between 31/7/1996 and 31/7/2001) £1,000 would now be worth £1,609. £1,000 invested in a 90-day notice account with Halifax PLC over the same period would be worth just £1,159. Source: Lipper Hindsight

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