Plan your tax-efficient ISA savings for this year now

Saving in an ISA (individual savings account) is one tax break too good to miss out on. We are now a couple of weeks in to the new tax year. Traditionally the so-called "ISA season" is at the end of the tax year, as savers and investors rush to take up the tax allowance before they lose it for good once the year-end has passed. However, it makes a lot of sense to save from the beginning of the year because you get a whole year's extra tax saving by doing it that way.

Human nature being what it is, many investors want to "wait and see" before committing their funds. The trouble with this strategy is that, while you may get lucky and pick the low point of the share or fund price, you may equally get unlucky and invest at the top of the market.

Not all ISAs are the same. Moneyextra is here to help you compare ISAs and find the right one for you.

How regular investing pays more than dividends

One way to do that is with regular investment. This means that over the course of the year you drip-feed your money into your chosen fund, taking advantage of a phenomenon known as pound cost averaging .

By putting your money into the market bit by bit, some of it will go in when prices are high and you will buy fewer units for your money. But some will also go in at a lower price, when you will buy more with the same amount of cash.

This is a sensible strategy for regular saving, and is generally considered to be a much better idea than saving the money elsewhere, perhaps in a savings account and then putting it all into a fund at once.

Critics of pound cost averaging point to potential higher dealing costs from piecemeal investment, and say that, since equities tend to rise in price over time, the material gain by investing bit by bit is negligible compared with the potential loss of having your money out of the market for any length of time. Opinions differ, but, whatever argument you favour, regular saving is certainly a good discipline to adopt.

Remember that if you save in an equity-based ISA - and you can put £7,200 aside under the new rules that came into force this year - you are getting not only the advantages of a stock market investment, but also valuable tax breaks, as any appreciation in the value of your fund is entirely free of capital gains tax.

Want to track your investments? Moneyextra's free portfolio service has all the tools you need.

Benefits for higher rate taxpayers

Unfortunately, if you are a basic rate taxpayer inside or outside an ISA, the company will already have paid tax on its profits and pays your dividend out of its post-tax income. Although dividends are treated as having a tax credit of 10%, this cannot be refunded to ISA investors, or indeed to non-taxpayers saving outside an ISA.

However, if you are a higher rate taxpayer you would normally pay further tax on the dividend income you receive from investments outside an ISA of 22.5%. While you will still receive dividends from the company's post-tax income, and will not be able to reclaim the 10% tax credit for what has already been paid, you will have no more personal tax to pay on the ISA investment.

28 April 2008 © Moneyextra.com

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Our senior editor Robin Amlôt recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.