For the vast majority of the UK working population, there are a few obvious ways of mitigating the amount of tax that you pay. All of these, however, mean giving up some of your income each month and switching some of it into the appropriate savings vehicles.
Alexander Garden says ISAs offer an attractive way of investing without being hit by capital gains tax (CGT) or tax charges on interest earned, and an individual can invest upto £11,280 a year."You get the tax-free roll up of cumulative interest and if you keep on doing that for 20 years you quickly have a basic pot of over £200,000, with the income from that sum being free of tax," he says. That kind of pot compares very well with the average private pension pot in the UK, which is estimated to be no more than £28,000.
Even if you can't invest to the full extent of your ISA allowance each year, putting a few thousand pounds aside annually will also roll up to a very attractive sum once a few decades have gone by. Remember, capital gains is either 18 percent or 28 percent, once your annual CGT allowance has been fully utilised, so an investment outside an ISA would have to gain enormously to compete with that kind of saving once it had been hit by CGT.
Alexander points out that this has been a difficult time for investing in shares, the asset class of choice for the majority of ISA savers.
"Markets have been volatile but have not really moved in terms of levels. We're back to where we were, really. But if there were to be a surge forward in equity values again, you would not want to miss out on that, and you would want to make sure that you did not have to pay CGT on any growth in your portfolio. Again, ISAs are a good way of achieving this," he says.
Many ISA investors choose to invest in blue-chip stocks that pay high dividends. You are always going to lose the compulsory 10 per cent tax that funds deduct at source before paying the dividend into your account. That fraction is not recoverable. But it is important to many to find that they are getting paid dividends in their ISAs without incurring the 32.5 per cent dividend tax for the higher-rate taxpayer. Cash ISAs, Alexander points out, are not much good for building any kind of capital growth, but they have their uses if someone is dipping a toe in the ISA waters for the first time and wants to do so in a highly liquid form.
"You always have the option of switching your ISA fund out of cash and into shares at some point, so cash is a good starting point for many who are new to investing in ISAs," he adds.
Alexander goes on to say that while cash does offer the benefit of being highly liquid, it has the huge disadvantage at present of attracting very low interest rates. The rates are well under inflation, meaning that cash ISAs are not holding their value over the course of a year.
With the government having frozen the £325,000 inheritance tax (IHT) allowance until 2018, IHT has come right back onto the agenda as something that some people need to think about.
Read the article in full in The Scotsman's End of Year Tax supplement online.