The seven pillars of ISA wisdom
Do not let the vast array of tax-free deals baffle you – follow a few simple steps
IN A world of financial complexity, it is hardly surprising that the Individual Savings Account has its flaws. There are too many versions and some niggly rules that can leave even the savviest of investors scratching their heads.
But the fact remains that the Isa still represents an effective – and flexible – way to accumulate wealth away from the clutches of the taxman. It makes a perfect saving companion to sit alongside a pension.
Isas are available to everyone – from newborns to those enjoying the fruits of retirement. For those under the age of 16, a maximum of £4,128 can be squirrelled away in the tax year ending April 5 this year. This rises to £4,260 in the new tax year. Adults can save up to £20,000 both in this financial year and next.
There is no tax to pay on income or capital gains generated within the Isa. But it is a ‘use it or lose it’ tax break. You cannot carry over unused allowances into the next tax year.
Here are the seven pillars of Isa wisdom to consider before you put money in between now and April 5.
1 DO NOT BE TIED TO CASH
CASH-based Isas, offered by banks and building societies, have been the most popular choice for those putting money aside for a rainy day.
You can put the entire £20,000 allowance in a cash Isa. But since the introduction of the tax-free personal savings allowance two years ago, the appeal of cash Isas has dwindled.
Now basic rate taxpayers can earn £1,000 a year in interest tax-free, while for higher rate taxpayers the allowance is £500 and for additional rate taxpayers it is zero. So the tax advantage of cash Isas no longer holds for most savers.
Ever-decreasing savings rates have further diminished the attraction of cash Isas. Top deals currently pay 1.3 per cent (instant access, Nationwide Building Society) or 1.45 per cent (fixed for one year, Aldermore).
Rachel Springall, savings expert at financial data scrutineer Moneyfacts, says those wedded to cash must shop around for top rates. She says: ‘Look beyond high street brands when comparing cash Isas. Some of the best returns are from less familiar names such as Aldermore, Paragon Bank, OakNorth Bank and Charter Savings.’
Watch out for bonuses applied to cash Isas. A short-term bonus often masks a low underlying rate. For example, the AA has an easy access Isa paying 1.16 per cent which puts it among the best-buys. Yet this includes a 0.96 per cent bonus for the first 12 months. Fail to switch after a year and the rate will plummet to 0.2 per cent. This is how Isa savers get caught out and end up with cash languishing at poor rates.
Remember, you do not have to just be a cash Isa saver. Angela Murfitt, a chartered financial planner at Fairstone in Leek, Staffordshire, says: ‘It is possible to subscribe to both a cash and stocks and shares Isa in the same tax year. You can hold either in any proportion as long as the total you pay in does not exceed £20,000.’
2 THINK INVESTMENTS
THOSE with more than just ‘rainy day’ money should invest in a stocks and shares Isa, even if it is a step they have never taken before. Fewer than one in five cash Isa savers also has an equity Isa. Also, less than 10 per cent of women opt for equity Isas. The full £20,000 allowance can be invested in equities or funds.
Greg Davies is head of behavioural science at consultant Oxford Risk. He says the jump from cash to equities makes many people uncomfortable. Davies adds: ‘People are put off investing because they fear getting it wrong, are overwhelmed by the complexity of it all and prefer to stick with the status quo that is cash.’
One of the attractions of an investment Isa is the potential for growth. The difference in performance between cash and the stock market is stark. Someone who ten years ago invested £15,000 in an investment fund replicating the performance of the FTSE All-Share Index would now have an Isa war chest worth £29,210.
In contrast, if the same saver had put their £15,000 into the average UK savings account, they would have a cash Isa pile worth just £15,478.
Research conducted by UBS SmartWealth suggests that if cash Isa savers had invested their contributions over the past five years, they would collectively be £46billion better off.
But Jeremy Squibb, a financial planner at Serenity Financial Planning in Helston, Cornwall, says equity Isas are not for everyone. He says: ‘If you are squeamish about seeing your capital fluctuate in value in the short term, or there is a possibility you may need your Isa money in six months to a year, then an investment Isa is not for you.’
3 BUY ONLINE
THE best way to set up an equity Isa is online via a so-called fund platform, giving you the freedom to put your own portfolio together and choose how much you put in and when.
Those who want to keep things simple can invest in a UK tracker fund. Consider Vanguard’s online offer. Its FTSE100 fund charges 0.06 per cent a year plus a 0.15 per cent account fee. The minimum investment is £500 for a lump sum or £100 a month.
Investors with smaller sums should look at Cavendish Online, which accepts a minimum of £50 a month. Investors can buy the Fidelity UK Index fund at an annual charge of 0.06 per cent, plus a 0.25 per cent annual account fee.
Justin Modray, director at independent Candid Financial Advice, says: ‘Do not underestimate the importance of choosing a suitable Isa platform as the quality of service and costs can vary.’
Holly Mackay, of Boring Money, is an Isa platform expert. She chooses her favourite providers overleaf.
4 SPRING CLEAN EXISTING ISAs
YOU have the right to change Isa provider, so look to see if you can get better value for existing Isas.
Murfitt says: ‘Isas can be transferred from one provider to another without affecting your annual allowance. Not all will accept transfers in, but all must allow transfers out. It means investors need not be stuck with poor rates in their cash Isas or high charges and poor performance from their stocks and shares Isa.’
5 CAST AN EYE OVER THE NEW
A NUMBER of new types of Isa have been launched – Lifetime, Help to
Buy and Innovative Finance – which may suit some savers.
The Lifetime Isa is available to those aged 18 to 39 and is designed to double as a home deposit builder and pension fund. The maximum annual contribution is £4,000, forming part of the annual £20,000 Isa allowance.
The money can be used to buy a first home. The big attraction is the Government pays a 25 per cent bonus each year until you are 50 – £1,000 on the maximum £4,000 annual saving.
If you are not using the Lifetime Isa for a home deposit, it could be a good start towards a pension, as you can take it out when you turn 60. But if you access it early, you will be hit with heavy penalties.
The Help to Buy Isa can also be used to save for a first home and is available to anyone over the age of 16 buying their first property (subject to a maximum property price of £250,000 or £450,000 in London).
Savers can put in up to £1,200 in the first month, then £200 a month. The Government pays a 25 per cent bonus of up to £3,000 (equating to £12,000 in the Isa) when you release the funds to purchase a first home.
You can open a Help to Buy Isa until November 2019 and the bonus is set to run until 2030 so savers have lots of time.
However, the Lifetime Isa may be more attractive to first-time buyers as it has higher savings limits. Savers with a Help to Buy Isa can transfer their savings into a Lifetime Isa. In some circumstances, a transfer before April 5 may result in a double bonus boost.
For 20-year-old IT technician Charlie Harrison, from Gateshead, Tyne and Wear, opening a Help to Buy Isa focused him on saving regularly.
Charlie, who lives with his mother, saves £200 a month into a Virgin Money Help to Buy Isa, which pays interest of 2.25 per cent a year.
He says: ‘I do not have a time frame for buying a house but I like the idea of saving regularly and watching my pot grow.
‘Knowing that I will get a boost from the Government when I do come to buy my own place is a big incentive.’
The Innovative Finance Isa was launched in 2016, letting savers invest tax efficiently in the growing peer-to-peer lending market.
Peer-to-peer websites enable individuals to lend direct to others and small firms, cutting out the banks and earning investors high returns of about six per cent.
Providers include Funding Circle, Folk2Folk, Triodos Bank and Zopa, but minimum entry investment levels can be high and your cash is not protected under the Financial Services Compensation Scheme.
If the businesses you lend to go bust then you have no recourse.
6 REMEMBER CHILDREN
JUNIOR Isas are ideal for parents or grandparents wanting to build a fund that their offspring can draw on at 18. Up to £4,128 can be saved in this tax year, rising to £4,260 from April 6. Those aged 16 and 17 can complement this with an adult cash Isa, perhaps helping to save for university or a home deposit. For Junior Isas, equities make more sense than cash, as investments have a long time to grow in value. For parents who are wedded to cash, the best rates are from Coventry and Nationwide building societies at 3.5 and 3.25 per cent respectively. Meanwhile, National Savings & Investments has just raised its rate to 2.5 per cent. Previously it was 2.25 per cent.