But what differentiates them?
One key difference is the amount of money you can invest in each fund. In the case of a general account there are no limits, whereas new contributions in an ISA are capped at £20,000 per tax year1.
The other big difference is the way investments held in either account are taxed. This can have a major bearing on your future wealth and it’s a difference that is set to grow in the years ahead.
ISAs shelter your savings from the tax liabilities you may otherwise incur as your savings grow. This is because no tax is due on any interest or income received from your ISA investments. You also pay no capital gains tax (CGT) on the profits you might make when buying and selling investments within your ISA, however big your ISA holdings get over time.
In the case of a general account, though, there is no such protection. Exceed your annual allowances and you could be faced with a tax bill on the dividends, interest and capital gains that you earn.
It’s a growing risk for general account holders too, given the government’s recent decision to cut these tax allowances.
The annual personal savings allowance isn’t changing and will remain at £1,000 for most basic rate taxpayers, £500 for higher-rate taxpayers and zero for additional-rate taxpayers.
But the amount you can earn per year from dividends (the payments some companies make to their shareholders out of their profits) and not incur tax is set to halve from £2,000 now to £1,000 come the start of the new tax year on 6 April and then again to £500 in 2024/25. How much tax you will have to pay depends on your income tax band2.
Everyone also gets an annual allowance below which they don’t have to pay CGT. This covers the profits a person might make from selling a second property or business interest, say, as well as the investments they hold. And for the current tax year it is set at £12,300 for most people.
In 2023/24, though, that CGT allowance will be reduced to £6,000 and then halved again to £3,000 on 6 April 2024.
Strike while it’s hot
We have warned before of the possibility of the CGT allowance being cut. But then government policies are always subject to change, so it’s important investors make the most of existing tax incentives while they can.
At present, higher-rate and additional-rate taxpayers pay 20% tax on capital gains above the CGT allowance (28% if earned from residential property). The rate is 10% (or 18%) below the basic-rate income tax band.
The difference it can make
To illustrate the financial difference that your choice of account can make, consider a higher-rate taxpayer who begins this year investing £20,000 per tax year in a globally diversified stock-market fund.
Imagine that the money is left fully invested and that over the next 10 years it earns an annual rate of return of 5% after costs, say. Factoring in current dividend, savings and CGT allowances and the expected reductions that will begin kicking in from 6 April, the chart below shows the difference it would make if the money was invested in an ISA compared with a general account and then those investments were sold at the end of the period.
In our hypothetical example, the ISA investors would earn £12,678 more – and all from just choosing a more tax-efficient account!
Source: Vanguard calculations. Notes: Based on the investment amounts described in the text. The 5% return used in the example is hypothetical and is not guaranteed (it is based on a 100% stock allocation with 1% income yield and 4% capital appreciation). Assumes a higher rate taxpayer with a personal savings allowance of £500, a dividend allowance of £2,000 falling to £500, and a capital gains tax allowance of £12,300 falling to £3,000. Dividends after tax are assumed to be reinvested and all capital gains are crystallised for tax purposes at the end of the final year.
The combination of tax efficiency and flexibility makes an ISA an ideal vehicle with which to begin investing. What’s more, you don’t have to disclose your ISA holdings on your tax return – unlike with a general account – so there’s less paperwork too!
Still, if you are lucky enough to have a lump sum greater than £20,000 to invest, you won't be able to put it all in an ISA – not in a single tax year. So you could consider putting anything above £20,000 in a general account to begin with – so it’s at least working for you in the market – and then move the funds into an ISA over subsequent tax years. This process is called “bed and ISA”.
You could also put some of the money into Junior ISAs for your children3.
If you are contributing to multiple ISAs in your own name in any given tax year, though, make sure not to breach the overall allowance of £20,000 across all of them. Remember also that you're only allowed to open one of each different type of ISA each tax year – for example, stocks and shares ISAs, such as the kind Vanguard offer, versus cash ISAs.
So, if you already have a stocks and shares ISA for the current tax year, you can't open another one until the new tax year.
Alternatively, you can transfer your existing stocks and shares ISA to a lower-cost provider – because costs, like tax, also drag on the performance of your investments. Due to the proximity of the tax year-end, though, we would suggest making the most of your current-year tax allowance before doing so, due to how long a transfer might take4.
Whatever your circumstances, we have an account for you. And, when you combine our account options with our high-quality, low-cost funds and easy application process, you have some great ways to gain access to world markets.
1, 3 In the case of Junior ISAs, the annual limit on contributions is £9,000. Please note that money placed into a Junior ISA cannot be accessed until the account holder turns 18.
2 Basic rate, 8.75%; higher rate, 33.75%; additional rate, 39.35%, as at 2022/2023.
4 ISA transfers normally take up to 30 business days.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
The eligibility to invest in an ISA o depends on individual circumstances and all tax rules may change in future.
If transferring, you will be out of the market while your investments are being transferred, so you could miss out on any increase in the value of your investments should markets rise. Should markets fall the value of your investment will remain the same.
Any tax reliefs referred to in this document are those available under current legislation, which may change, and their availability and value will depend on your individual circumstances. If you have questions relating to your specific tax situation, please contact your tax adviser.
If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described in this document, please contact your financial adviser.
This article is designed for use by, and is directed only at, persons resident in the UK. The information contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.
The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.
Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
© 2023 Vanguard Asset Management Limited. All rights reserved.