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What is a stocks and shares ISA?

As a longtime writer for The Motley Fool, I love investing. And if there’s anything I love more than investing, it’s investing with tax advantages. And that’s what’s great about a stocks and shares ISA.

A stocks and shares ISA is very similar to a bog-standard sharedealing account in terms of the functions it provides. For example, it allows an investor to buy shares, bonds and a range of other assets.

However, it also offers tax efficiency. This is a key reason why many investors open a stocks and shares ISA instead of (or in addition to!) an regular online sharedealing account.

While there are many advantages to using a stocks and shares ISA, there are risks as well. Plus it’s usually a good idea to shop around for an account provider that fits your needs. So let’s dig in and take a closer look.

The annual stocks and shares ISA allowance

Since there are tax advantages involved, it’s probably not too surprising to hear that there are limits to how much you can invest in a stocks and shares ISA. The maximum amount that can be invested in one of these accounts each tax year is £20,000.

It’s also important to note that this annual allowance is a cumulative figure across all types of ISAs. So if you go ahead and invest the full £20,000 in a stocks and shares ISA, you wouldn’t be able to invest in a cash ISA, innovative ISA or other types of ISA. Likewise, it is not possible to repay amounts that are withdrawn from a stocks and shares ISA, unless the payments form part of the annual allowance. Which means that if you pull £1,000 from your account, you can still only put £20,000 into it during the tax year (not £21,000).

Tax efficiency of stocks and shares ISAs

Perhaps the main reason for having a stocks and shares ISA is its tax efficiency. The money invested in a stocks and shares ISA is not subject to capital gains tax or dividend tax. This could mean a significant amount of tax savings during the course of a lifetime.

For example, imagine if you bought shares in a company for £5,000 and sold them later for £20,000. Normally, there would be £3,000 of capital gains subject to tax (after the £12,000 annual allowance is deducted). This would be taxed at either 10% or 20% depending on whether you are a basic-rate or higher-rate taxpayer. But if those shares were held in a stocks and shares ISA, you wouldn’t be subject to that tax. In this case, a basic-rate taxpayer would save £300, while a higher-rate taxpayer would save £500.

Turning to dividends, the annual allowance for dividends received outside of a stocks and shares ISA is £2,000. Someone who has an annual dividend income of £20,000 would be taxed at 7.5% or 32.5%, again depending on whether they are a basic-rate or higher-rate taxpayer. That would mean £1,350 in taxes for the basic-rate payer and £5,850 for the higher-rate payer. But, once again, an investor using a stocks and shares ISA would be saved this hefty tax bill.

The types of investment available

A stocks and shares ISA allows an investor to buy a wide range of assets, such as shares, funds and bonds. In fact, it generally offers the same range of choice as a bog-standard sharedealing account.

As a result, it is generally viewed as a riskier proposition than other types of ISA, like a cash ISA. Assets such as shares and bonds put capital invested at risk, and that means that an investor’s portfolio may fall in value.

However, over the long run, investments such as FTSE 100 shares have historically risen. In fact, the FTSE 100 index has posted annualised total returns (that is, capital growth plus dividends received) in the high-single digits over the long run. As such, investing in a range of shares has the potential to grow your savings while capitalising on the tax efficiency offered by a stocks and shares ISA.

And now, the costs

The cost of opening and managing an ISA can vary significantly between different providers. Therefore, it is worth shopping around through comparison sites such as MyWalletHero. Doing so could allow you to find the best deal based on your own personal circumstances. For example, some providers may offer discounts for frequent traders, while others may offer different service options depending how you plan to invest.

Overall, though, the cost of having a stocks and shares ISA versus a sharedealing account is often fairly insignificant when the tax benefits of the former are factored in. Therefore, if you are thinking of investing in the stock market or in another mainstream asset such as bonds, a stocks and shares ISA is definitely worth keeping in mind.

Ready to open a stocks and shares ISA? Check out our stocks and shares ISA reviews to help find the right online provider for you

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