An Individual Savings Account (“ISA”) is an investment account that allows UK taxpayers to contribute post tax funds on an annual basis (up to £20,000 per annum).
An Individual Savings Account (“ISA”) is an investment account that allows UK taxpayers to contribute post tax funds on an annual basis (up to £20,000 per annum).
Restrictions in the amount you can contribute into a UK pension has reduced some high earners options, an ISA can be a very good way of investing in a tax efficient account. The best part is: you do not pay tax on the growth or interest/dividends in your ISA. This means, if you have a cash ISA, all interest earned in the ISA is always tax-free. If you have a stocks and shares ISA, you do not pay tax on any dividends from shares and you do not pay capital gains tax on any profits made from the investments. Additionally (and unlike a pension), an investor will not have to pay income tax on any withdrawals.
Unfortunately, the Internal Revenue Service (“IRS”) consider an ISA as 'look through for US tax purposes'. This means that the investments held within the account will be taxed in the US; effectively eliminating the tax-free benefit and raising the question, ‘Are ISAs worth it?’
In response I would say yes, I believe it is, as the differential in tax rates between the UK and US can still make investing via an ISA for a US taxpayer slightly beneficial compared to investing into an account that is deemed look through for US tax purposes.
It all comes down to the different tax rates. In the US, most individuals that crystallise a capital gain are taxed to the long-term rate of 15%, whereas a US citizen UK resident that chose to invest outside of an ISA would be taxed to the UK capital gains rate which is currently 24% for a high-rate taxpayer. Similarly, any dividends or interest payments are taxed to income rates (federal); in the US, this is up to a maximum of 37%, whereas for a similar high earner the UK income tax bracket is 45% for interest and 39.35% for dividends.
Although the tax differential is low, when a portfolio grows in size the monetary saving can be significant. An example of the tax differential can be seen below:
A pitfall we often come across is the underlying holdings within an ISA. A typical stocks and shares ISA will most likely be invested in Open Ended Investment Company's (“OEICs”), investment trusts, or exchange-traded funds (“ETF’s”). These investments will still be deemed Passive Foreign Investment Companies (“PFIC's”) even though they are held within an ISA and the dreaded PFIC rules will apply.
Providing your ISA is invested correctly and the investments are taxed to "qualifying rates" then an ISA is a good way to reduce your tax burden.
You must however take care in ensuring that any ISA is included on your Foreign Bank Account Report (“FBAR“).
Here are a few additional points to consider to make the most of your ISA allowance, now and in the future:
This article was originally published on 13 February 2024 and has since been updated.
Capital Gains Tax rates and allowances - GOV.UK
Topic no. 409, Capital gains and losses | Internal Revenue Service
Chris is a Wealth Manager at LGT where he manages discretionary mandates on behalf of Private Clients, Charities and Trustees. Prior to joining LGT Wealth Management US, he worked within the UK private client team at LGT Wealth Management UK LLP.
Chris received a distinction in his PCIAM, he also holds the CISI Investment Advice Diploma and a BA (Hons) in Business Studies. Chris is a member of the LGT Wealth Management US Investment Committee.
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