Skip navigation Scroll to top
Scroll to top

ISAs for US citizens – are they worth it?

28 April 2021
ISAs

Chris Gabbett, Wealth Manager

An ISA (Individual Savings Account) is an investment account that allows UK taxpayers to contribute post tax funds on an annual basis (up to £20,000 per annum). With high earners now severely restricted in the amount they can contribute into a UK pension, an ISA can be a very good way of investing in a tax efficient account. The best part is: you do not pay tax on the growth or interest/dividends in your ISA. This means, if you have a cash ISA, all interest earned in the ISA is always tax-free. If you have a stocks and shares ISA, you do not pay tax on any dividends from shares and you do not pay capital gains tax on any profits made from the investments. Additionally (and unlike a pension), an investor will not have to pay income tax on any withdrawals.

Unfortunately, the IRS (Internal Revenue Service) consider an ISA as 'look through for US tax purposes'. This means that the investments held within the account will be taxed in the US; effectively eliminating the tax-free benefit and raising the question, ‘Are ISAs worth it?’

In response I would say yes, as the differential in tax rates between the UK and US still makes investing via an ISA for a US taxpayer slightly beneficial compared to investing into an account that is deemed look through for US tax purposes.

It all comes down to the different tax rates.  In the US, most individuals that crystallise a capital gain are taxed to the long-term rate of 15%, whereas a US citizen UK resident that chose to invest outside of an ISA would be taxed to the UK capital gains rate which is currently 20%. Similarly, any dividends or interest payments are taxed to income rates (federal); in the US, this is up to a maximum of 37%, whereas for a similar high earner the UK income tax bracket is 45%.

Although the tax differential is low, when a portfolio grows in size the monetary saving can be significant. An example of the tax differential can be seen below: 

ISAs_2_1200x750

A pitfall we often come across is the underlying holdings within an ISA. A typical stocks and shares ISA will most likely be invested in OEICs (Open Ended Investment Company's), investment trusts, or exchange-traded funds. These investments will still be deemed Passive Foreign Investment Companies (PFIC's) even though they are held within an ISA and the dreaded PFIC rules will apply.

Providing your ISA is invested correctly and the investments are taxed to "qualifying rates" then an ISA is a good way to reduce your tax burden.

You must however take care in ensuring that any ISA is included on your FBAR (Foreign Bank Account Report).  

Here are a few additional points to consider to make the most of your ISA allowance, now and in the future:

  • Use it or lose it - your ISA allowance, currently £20,000, does not roll over to the next tax year.
  • Are your wider family making the most of the allowance? All UK residents over the age of 16 are entitled to an annual ISA allowance.
  • Be an early bird. Invest your allowance at the start of the UK tax year (6th April) for maximum benefit.
  • Use your new ISA allowances each year to continue adding to your ISA.

 

This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Vestra LLP and/or its affiliates gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Vestra LLP, employees and associated companies for any direct or consequential loss arising from this document.

LGT Vestra LLP, LGT Vestra (Jersey) Limited and LGT Vestra US Limited are affiliated financial services companies (each individually an “Affiliate). LGT Vestra LLP is authorised and regulated by the Financial Conduct Authority in the United Kingdom. LGT Vestra (Jersey) Limited is incorporated in Jersey and is regulated by the Jersey Financial Services Commission. LGT Vestra US Limited is Authorised and Regulated by the Financial Conduct Authority in the United Kingdom, and is a Registered Investment Adviser with the Securities & Exchange Commission in the United States.