Make your Isa as valuable as your pension

Our trailblazing Personal Finance Editor shows how to make your Isa as valuable as your pension

SOME 19 long years have passed since Gordon Brown made one of his smarter moves as Chancellor of the Exchequer – and launched the Individual Savings Account. A long- term investment ( not savings) vehicle providing shelter from the bane of all our lives – horrible, nasty tax. So, no tax on any growth or income generated within the account and no tax on any capital gains made. A tax-free investment zone.

Although Brown’s original version was not that sexy and full of irritating rules, the Isa has staunchly survived umpteen changes of Chancellor and governments. Indeed, in recent years the Isa has been updated and given a new lick of paint while a few of the confusing rules have been weeded out.

The Isa will always have room for improvement but if used wisely it can help to build serious wealth. I would contend it is now as important in financial planning as a pension, especially given the panoply of limits and restrictions currently applying to pensions.

According to Hargreaves Lansdown, one of many companies to provide the Isa wrapper, some people have done outstandingly well by investing in Isas. It currently has 211 Isa millionaires under its wing, up from 168 in March when it last disclosed such data. These people have invariably invested the maximum permitted every year – currently £20,000 – and in addition have been shrewd in their choice of shares and investment funds.

Most are reluctant to talk about their Isa millionaire status although Lord Lee of Trafford – John Lee, a Conservative Minister in an earlier life – is an exception.

He has gone on record to say his Isa is now valued at ‘several millions’. A fact I confirmed last week in a brief email exchange with the good Lord who invited me to have a spot of lunch at the House of Lords.

Indeed, John Lee is now more famous for his Isa exploits than he ever was as Minister of Tourism under Margaret Thatcher in the late 1980s. He’s been so successful on the Isa front that he has written a book about it: How To Make A Million – Slowly. Go online and you can pick up a copy for £8. Well worth a read.

The latest statistics, courtesy of those normally tax-grabbing people at HM Revenue & Customs, indicate that between us, as adults, we now have £608 billion sitting within Isas. A big number on any level although the average Isa pot stands at a modest £21,000.

Like so many personal finance tools, one of the big problems with Isas is perception. They appear complicated, in flexible and shrouded in reams of jargon. So, people stay away from them. A point made to me last weekend as I took time out to walk two excitable canine friends on Port Meadow in Oxford with a longstanding financial planner. Many people, she confirmed, come to her convinced they don’t have enough disposable income or savings to entertain an Isa in their financial life. They can then become quite enthusiastic to be told nothing could be further from the truth.

These are just the people Isas are designed for. Here are seven key facts about Isas that will ignite your interest in them – and help you to understand them better.

1 HOW TO INVEST IN FUNDS AND SHARES

ALTHOUGH the acronym suggests this is a savings tool, it is a misnomer. An Isa should really be called an LTIA – a long-term investment account. This is because it works best if you use it as a nest-egg-building tool, investing any contributions into shares or investment funds. Yes, you can hold cash in it – and more than 40 per cent of all Isa balances are cash-based – but this represents a wasted opportunity. Why? Two reasons.

First, deposit rates are still Scrooge-like.

Second, because a relatively new personal savings allowance now allows most people to earn £1,000

of interest from cash deposits tax-free every year – £500 if you are a 40 per cent taxpayer.

In other words, you can hold more than £166,000 in an average paying (0.6 per cent) instant access account outside an Isa and still not pay tax on any interest.

So, use your personal savings allowance for cash and then invest via an Isa – into shares and investment funds.

Preferably t hrough one al l - embracing online account that allows you to dictate how your money is invested.

For the record, your Isa money can be invested how you like and for as long as you like.

2 YOU CAN TAKE MONEY OUT PENALTY-FREE

UNLIKE pensions, there are no restrictions, penalties or tax to be paid on withdrawals – something most people do not grasp. So, you can make tax-free withdrawals to dovetail with your financial needs or in later life to supplement a State pension or income from a private or company pension. You have complete control.

3 DRIP, DRIP... THE MONEY WILL SOON BUILD UP

WHILE t he maximum annual investment per tax year is currently £20,000, you do not have to do a Lord Lee and utilise it all. The best approach is to invest as much as your household budget can afford every month. Set up a direct debit so that you almost forget the money is coming out of your bank account – and you get used to a little less spending power.

Then, if you come into any money as a result of work overtime or a bonus, channel a slice of that into your Isa as well.

Sarah Coles, personal finance analyst at Hargreaves Lansdown, perfectly encapsulated the virtue of this approach when I asked her for some Isa thoughts a few days ago. ‘The best route to Isa success,’ she said, ‘is to avoid death-defying risks and short-cuts. Think of it as a long gentle ascent, requiring stamina and commitment.’

Translated into investment speak, what she means is adopt a ‘get rich slow’ approach by investing in a diversified portfolio of household names and well-respected invest- me ment funds, preferably with expos sure both to UK and international stock markets.

4 MOVE FROM CASH INTO INVESTMENT

ALTHOUGH Isa rules have chopped and changed with great regularity over the years, they are usually for the better. An important change is the one that allows you to move money from an existing Cash Isa across to an investment- based Isa – a move previously prohibited. It is easy to do and will give your Isa money a greater chance in the long term of increasing in value. MANY MA people still hold an odd assortment ass of shares as a result of investing inv in past privatisations or benefiting ben from businesses demutualising. tua For example, Royal Mail (a share currently in freefall) or Standard St Life.

What some investors do not know is that t these shares can easily be transferred tra into an Isa through a process pro called ‘bed and Isa’, thereby protecting pro them from future tax on dividends or capital growth. di

What happens is that the shares are sold ( the bed bit) and then immediately imm bought back within the Isa (the Isa bit) with the sale proceeds. pro Although capital gains tax is potentially chargeable on the sale sal of the shares, most people will avoid avo this because they will be able to use u their annual tax-free capital gains gai tax allowance of £11,700.

6 WHY COMPOUNDING IS SO POWERFUL

THERE may come a time when you want to use your Isa to pay yourself an income, but in the meantime it makes good financial sense to reinvest any dividends within the Isa wrapper. It will compound the growth in the plan’s underlying assets. One fact proves how powerful compounding is. If you had invested £10,000 in the UK stock market before the 2008 financial crisis, it would today be worth nearly £ 15,000. If you had reinvested the dividends as you went along, it would be worth in excess of £21,000.

7 STICK AT IT – THROUGH THICK AND THIN

FINALLY, to be a successful Isa investor, you really need to stick with it through thick and thin. That means being prepared to ride out periods of stock market volatility – even when everyone else is telling you to sell. Stay committed. It might not make you an Isa millionaire but it will give you a chance of financial security in later life.