LONDON, 17 March 2010 – While many savers use Individual Savings Accounts (ISAs) to take advantage of their tax status to boost their personal savings and investments, research from Vanguard UK highlights that, for many investors, the typical fees charged for an ISA often outweigh their tax savings.
For example, a basic rate tax payer invests £5,000 in a UK corporate bond fund ISA. Assuming an average yield of 4.5 per cent, this investor should benefit from a tax saving of around £45. But, as the average charge on such a fund amounts to over £50 per year*, the investor would actually lose more in charges than they’ve gained in tax savings! If this investor put that £5,000 to work in a low-cost ISA, such as one investing in low cost index tracker funds, the cost of doing so could be as little as £10**. Therefore, the investor would get to keep over 75 per cent of their tax relief.¹
A higher rate tax payer would also benefit from a low-cost approach. For example, £10,000 invested into an equity growth ISA would achieve an income tax saving of around £50 per year –assuming an average yield of 2 per cent. The costs of going down this route are much higher, typically over £150 per year for an active fund*. So the investor stands to lose three times what they’ve gained in tax relief! Again, a low-cost ISA could cost £20 a year** and therefore the investor would get to keep around £130 more per year. Even before compounding, that could amount to £1,300 over 10 years. ²
Tom Rampulla, managing director of Vanguard UK, comments: “Costs matter. For many investors, charges on their ISA outweigh the tax savings. By choosing low cost funds, such as index trackers within your ISA, investors can keep more of their tax relief, which is after all the reason that we have ISAs. Whilst the annual savings outlined above may not seem huge, it soon adds up over the years and can make a significant difference to your return.”
NOTES TO EDITORS
¹ For basic-rate tax payers, estimated at 25 million people, who contribute £5,000 into a corporate bond ISA, the expected income tax savings, generated by avoiding an effective 20% tax on the interest income of say 4-5% from a UK corporate bond fund, will be in the range of £40 to £50 per annum.
² The annual allowance for realising tax-free capital gains is currently £10,100 according to www.direct.gov.uk. The calculation to get £1,300 compound return is: (£150 - £20)*10 years = £1,300 Assumes constant expense ratio of 0.2% for Equity index trackers and 1.6% for average UK Equity funds.
Cost alone is not the only reason to choose a fund. Active managed funds may result in either out or under-peformance of an index, whereas a tracker fund seeks to mirror the performance of an index.
* Source: Review of UK Fund Fees – Lipper April 2009 – this report characterises simple average expense ratios and excludes any other costs such as initial charges, exit fees, SDRT and implicit transaction fees.
** Based on the average cost of Vanguard’s UK domiciled Equity Index Funds and Vanguard’s UK Investment Grade Bond Index Fund.
Table 1:
| | | Estimated income tax saving by investing in an ISA by tax bracket (dividends/interest income) |
| | Typical TER+ (Industry++/Vanguard) | Basic rate (0/20%) | Higher Rate (22.5%/40%) | Additional Rate (32.5%/50%) |
| Tax payers in bracket | N/A | 25.4m (@90%) | 2.9m (@10%) | 100k? (<1%) |
| Equity fund: 7% growth, including 2% dividends** | 1.6% / 0.23% | 0% | 0.45% pa | 0.65% |
| Corporate bond fund: 5% interest income** | 1.15% / 0.2% | 1% | 2% | 2.5% |
