ISAs for Contractors

With the challenges of IR35, income sharing clampdowns and other vindictive Contractor focused attacks by HMRC, it is vital that contractors fight back and ensure that they make use of the dwindling number of tax breaks still available. The message is a simple one - don't pay tax if you don't have to.

A case in point is what you do with your hard earned salary and dividends. Rather than hold monies on savings accounts that will then generate taxable interest our clients have been able to build up a substantial 'nest egg', by using all or part of their Individual Savings Account (ISA) allowance. For over a decade now in each tax year (ending April 5th), contractors can invest up to £7,200 into this tax efficient 'wrapper'. 'ISA allowances cannot be carried forward to the next tax year and so it's a case of use it or lose it unfortunately.

In the 2009 Budget, it was announced that from the 6th April 2010, the ISA allowance will increase to £10,200. For those investors who will be 50 on the 5th April 2010, you can use up to the current £7,200 allowance for now, but can also top up with extra £:3000 after the 6th October 2009 as the new allowance will apply to you earlier and you can exploit the higher limit for 2009/10 too.

ISA investors can deposit a maximum of 50% of your allowable portion in a cash based ISA, 100% in an equity (stock market) based ISA or a mixture of both.

Equity ISAs
Historically the best use of these tax breaks has been to invest in a good equity based investment such as a unit trust, investment trust or similar share based fund. Given the fluctuations of the stock market ContractorFinancials would always advise that you think in terms of a 5 year + term for the equities portion to allow your investment to have time to grow. There are over 1000 different funds that can be invested in but we have chosen a handful of providers that we feel comfortable with in the chosen field based on past performance and future prospects. If you would prefer to meet one of our advisers to discuss individual circumstances then we are happy to help. You'll note that no one provider is strong across the board, so it's essential to be selective in your choice of manager in the area that you have chosen to invest.

Contractor Financials strongly advises you to avoid the end of tax year rush to invest and to begin monthly contributions instead. Investing at the last moment at the end of the tax year may mean that you are buying at an artificially high level as the markets are boosted merely because of last minute Isa investors. It costs no to drip feed your Isa and it helps to smooth out fluctuations in the markets because you are only committing a fraction of your total investment each month. When prices take a dip you buy more of your investment for that month's contribution to make up for the fact that the previous months prices may have been higher. This is an excellent way to spread the risk associated with picking the right time to invest and helps you budget to save. Too often contractors miss out on this valuable tax break because you we don't have the cash when the March deadline appears (ask yourself whether you've fallen into this trap in the past!)

Drop us a line and let us know which fund you would like to invest in and we will have an application out to you that afternoon. If you have your own preference for a fund, other than those mentioned on ContractorFinancials then let us know and we'll get the paperwork to you.

Contributions can be easily altered to suit your changing budget and you make no commitment to the provider beyond this month's investment.

Cash ISAs
For money that you are likely to need in the shorter term or if you require complete security from the fluctuations of the stock market then a cash ISA can be accessed at any time often without notice and should attract far higher interest rates from banks and building societies than a similar size investment into one of their ordinary accounts. This unexpected generosity is because the institutions will expect to have your money for longer. They hope that you will probably not withdraw funds sheltered in this tax break if you can help it and they will therefore reward you for what they hope will be a longer term balance than a normal account.

'Protected ISAs'
Some providers have equity based ISAs that track stock markets but that have varying degrees of protection for the underlying fund value. In this way contractors could benefit from some measure of the potential growth of equities but also have a degree of security to their money.

Insurance ISAs
Should you choose to invest into a combined cash and equity ISA (see decision helper) you also have the option to place up to £1000 this year into an insurance fund within your ISA. These funds may offer less equity exposure than a purely stocks and shares fund and may therefore offer lower growth potential but they can diversify into such areas as property and government bonds.

Pension or ISA?
The answer is probably both if you can. Whilst pensions attract a far more lucrative initial tax boost in the form of relief at your highest marginal rate i.e. 40% (in effect the government will be putting money into your pension on top of what you contribute) they are relatively inflexible when you try to take the benefits. Whilst you should be able to take a proportion of your fund as a tax free cash lump sum, the income is taxable. You cannot access these funds before 50 and eventually part of your money must be used to an annuity. With an ISA you call the shots and take the money out tax free when you choose.

On a cautionary note, however, contractors must ask why the government is so generous when we make pension investment? The answer must be that they are giving us this incentive now so that we can provide for ourselves in retirement realising that the state can no longer afford to do so. In this respect the ISAs flexibility is also its drawback because there will always be the likely-hood that this money could be dipped into for emergencies/holidays etc and not be there to fund 'the longest holiday of your life'.

The best answer is probably to invest in ISAs for the medium term and to try to make pension provision for the longer term.

Click here to download our 'ISA Aid' - a decision tree to help you work out how much you can invest, and where (RTF Format).

It is important to understand that these investments are longer term in nature and that the value of investments and income from them can fall as well as rise. Past performance is also no guarantee of future performance.

If you would like to open an ISA, please read our Private Client Agreement and Contact Us.

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