Cash in on your tax-free options
MOST people don’t have much money to set aside right now but if you have, it may be worth saving it in your tax-free Isa allowance.
Time is running out to use this year’s allowance as the deadline is midnight on April 5, but you will get a new allowance from April 6, so it isn’t as urgent as it was.
It’s still a good prompt to put money away for the future, though so consider acting now.
Why is the Isa allowance useful?
Isas, or individual savings accounts, are designed to encourage people to put money away for the future, by offering valuable tax savings.
All the money you pay in is free of income tax and capital gains tax for as long as you keep it there. Withdrawals are also tax free.
When you die, your partner can even inherit its tax advantages, although after that, the money may be subject to inheritance tax.
The Isa allowance was increased to £20,000 in April 2017, which makes Isas seem like a tax break for the very rich, but it can still make sense for those on low incomes to save smaller sums if they can.
Is this tax break as good as it looks?
If you’re well off, with money in the bank and stock market investments as well, then investing in Isas is a nobrainer. But for those with less cash, there’s another option that could be just as useful.
People who keep money in non-Isa cash deposit accounts benefit from a tax break called the personal savings allowance (PSA), which was launched in 2016, says Laura Suter, head of personal finance at AJ Bell.
Under the PSA, basic-rate taxpayers can earn £1,000 a year in savings interest before paying income tax on the money, while higher-rate payers can earn £500.
“Today’s rock-bottom savings rates mean most people can amass significant sums in a bank savings account before they pay any tax,” Laura says.
A basic-rate taxpayer earning 0.5% in interest could have £200,000 in savings and would still be covered by the PSA, while a higher-rate payer could have £100,000 before tax was due, she calculates.
Laura says this could change if cash Isa rates improve, so people earn more interest, but that day seems a long way off. In most cases, if you can get a better rate from a normal savings account, it’s probably worth doing that.
What types of Isa are there?
There are two main types: cash Isas and stocks and shares Isas. Cash Isas are safer, of course, but over the longer run, stocks and shares Isas should deliver a superior return – but with a lot more volatility along the way.
Those who have taken a chance on stocks and shares Isas have reaped the rewards of the bull run over the past decade, but may now be feeling nervous as skyrocketing inflation and the war in Ukraine threaten to bring markets crashing down.
There is a third type, called the
Innovative Finance Isa, says Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, which let you to put money into crowdfunding schemes and peer-to-peer (P2P) loans, and pay no tax on your returns.
“These are much riskier than savings accounts, and operate more like investments,” Sarah says. They often offer return rates from 5% to 15% a year, but this is not guaranteed.
Another option is the Lifetime Isa or Lisa, aimed at helping young people build a deposit to get on the property ladder. You get a 25% Government bonus worth up to £1,000 a year on the money you invest. £1,000 a year. It is open to savers aged from 18 to 39.
You need the right blend of savings and investments to match your attitude to risk, Sarah says. “As you get older, you should be taking fewer chances with your money, as you have less time to recoup any losses.”
Who sells them?
Almost every bank and building society offers a cash Isa, but some banks make more effort than others.
The Lloyds Bank Cash Isa Saver pays a frankly pathetic 0.01% a year. The Barclays Instant Cash Isa isn’t much better at 0.05%, rising to 0.1% on any money above £30,000.
The best rates are paid by smaller building societies and challenger banks. Shawbrook Bank pays a best buy rate of 0.66% with instant access (still far below today’s 5.5% inflation rate). Another challenger, Paragon Bank, pays 0.65%.
Yorkshire BS pays 0.6% up to £9,999, again, with easy access. This rises to 0.65% up to £50,000 and 0.7% on holdings above that. Leeds Building Society pay 0.65% on £1,000 and above.
Scores of fund managers offer thousands of investment funds that you can buy inside your tax-free stocks and shares Isa wrapper.
The best way to buy them is through an online fund platform, which typically offer big discounts on upfront charges and give you the flexibility to switch between different funds at minimal cost.
Bestinvest, AJ Bell, Fidelity Personal Investing, Cavendish Online, Hargreaves Lansdown, Interactive Investor, Nutmeg, Vanguard LifeStrategy, Wealthify and others offer this option.
There are literally thousands of funds, investing in every region of the world, so make sure you understand what you are buying, or take independent financial advice.
Can I invest just a little money?
Isas are hugely flexible. You can save in cash from as little as £1, while most stocks and shares Isas allow lump sum investments from £100 or regular monthly contributions from as little as £25, depending on the platform.
You can stop and start contributions, and make tax-free withdrawals at any time. This makes them more flexible than pension savings, which you cannot access until age 55, says Jason Hollands, managing director at Bestinvest.
“For most people, pensions are best reserved for their intended purpose, to fund retirement, while Isas are suited to medium-term goals such as paying off your mortgage, education fees, wedding costs, a dream holiday or simply a rainy-day fund,” he says.
Avoid raiding funds if you can, and leave them to grow for the longer run.
Am I free to move provider?
Yes, and you can switch between cash and stocks and shares Isas (and back again). Now is a good time to review existing Isa holdings to see if they are still right for you, or if you can get a better return by transferring money elsewhere.
You can consolidate your Isas with one provider to make it easier to manage, says Sarah Coles. “Just check your new provider accepts transfers in.”
Can I use Isas for income?
Stocks and shares Isas are a great way of generating retirement income without having to pay tax. While cash Isas pay rock-bottom interest rates, you can get a much higher yield from the stock market.
The popular Fidelity Moneybuilder Income, for example, currently yields 3.41% a year, minus an ongoing charge of 0.56%, meanwhile the City of London Investment Trust, yields 4.78%, with an ongoing charge up just 0.38%.
These are invested in the stock market so the risks are greater, but that is less of an issue for the long term.
You can earn just £2,000 a year in dividends outside of an Isa before you start to pay tax on the money, says Laura Suter.
“From April that will be at 8.75% for basic-rate taxpayers and 33.75% for higher-rate taxpayers,” she says. Inside an Isa, they are free of tax. “An investor taking £10,000 in dividends in a year could see their tax bill cut by £3,148.”