Updated: Jul 31
The UK government introduced an advantageous savings vehicle in 1999 and has increased the maximum amount that we can save in those several times since. At the time of writing in 2023, we can contribute up to £20,000 to such a plan annually.
There are 4 types of ISA:
Cash ISAs - A Cash ISA functions mostly in the same way as a standard savings account. However, if you have a Cash ISA, you will not pay tax on the interest you earn, whereas if you have a savings account with a bank or building society, you will pay Income Tax on earnings over £1,000.
Stocks and Shares ISAs - Your money is invested in assets like shares, bonds, property, and commodities in a Stocks and Shares ISA (also known as an investment ISA), and you don't have to pay tax on capital gains or income (interest and dividends).
Innovative finance ISAs - You can become a lender with an ISA by lending to qualified individuals and businesses using an online peer-to-peer lending platform in exchange for a defined amount of interest over a certain length of time and paying no tax on the interest you earn.
Lifetime ISAs - You can save for your first home and/or retirement by contributing to a Lifetime ISA, and you won't have to pay tax on your earnings or capital gains. The government will add 25% to your investment (maximum £1000). Your maximum contribution for the year is £4,000 and if you are not using the money for your first home, you can access funds after turning 50.
Cash ISAs are considered typical international bank accounts in the United States, with interest taxed at ordinary rates. When it comes to stocks and shares ISAs, though, you'll need to be cautious in determining the underlying investments. If the investment is in individual shares or bonds, the income is treated similarly to interest from a cash ISA, with income flowing to the appropriate section of the return (for example, schedule B, D, etc.) based on the nature and classification of the income produced.
We will cover all three of the issues that are controversial regarding setting ISAs up for Americans in the UK. The three issues are PFICs, HMRC reporting funds, and the tax situation between the jurisdictions.
If you walk into many of the high street banks, they won’t even permit you to buy one of their off-the-shelf ISAs (except for a cash ISA). With this, they are actually doing you a favor as the IRS in the United States would classify these investments as PFICs (Passive Foreign Investment Companies), which can become very costly from a tax vantage point. You can find plenty of information on the internet on why Americans should avoid this at all costs, even if you take the QEF election.
The HMRC has a strict list of funds that meet their qualifications and are approved as offshore reporting funds. We utilize this guideline even for ISAs to keep all our clients’ portfolios consistently independent of whether they invest in a tax-advantaged wrapper or in a general investment account.
The real reason that funding an ISA becomes controversial for Americans is the tax situation. In the UK, the growth and distribution of an ISA will not be taxed. However, the US does not recognize this tax advantage and will, therefore, tax the account as if it were a regular investment. So, why would we want to shift the tax burden from the UK to the US? Simply because US capital gains tax rates on passive income are lower than UK tax rates.
For the UK tax year 2023, the tax-free dividend allowance is £2,000 (reducing to £1,000 from April 2023 and £500 from April 2024). Dividends above this level are taxed at:
8.75% (for basic rate taxpayers)
33.75% (for higher rate taxpayers)
39.35% (for additional rate taxpayers)
Capital gains also have a tax-free allowance of £12,300 (reducing to £6,000 April 2023 and to £3,000 April 2024), but thereafter you will pay 20% taxes (unless you're in the basic rate tax band) which, apart from those making a significant salary, is higher than the rate in the US. Therefore, you're better off paying US taxes and avoiding UK taxes by placing the money in an ISA.
With all these complications of even setting up an ISA for this small portion of the American population in the UK, you will find only a few firms that offer them properly. Dunhill Financial has partnered with Morningstar Wealth Platform (formerly Praemium) to offer compliant portfolios that can be utilized in ISAs. Morningstar Wealth Platform (formerly Praemium) issues 1099s to make your US taxes as simple as possible and we ensure that we use no PFICs (i.e., all US-listed securities) and that all funds are HMRC reporting funds. To learn more about this offering, please see our portfolios here.
Get in touch with our expert advisors to see how they can help in your situation.
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