Use it or Lose it: Pick the right ISA as the deadline approaches
With the introduction of the flexible Lifetime ISA in April 2017 there are now seven different types of ISA available to savers and investors, each with unique characteristics and benefits and drawbacks according to individual circumstances and requirements. Click for more.
In his article – ‘KISS’ – Humbug Joins Telgraph’s Campaign to Keep ISAs Simple – DIY Investor’s tame investor lamented the fact that the proliferation of ISA account types has robbed us of the intrinsic simplicity of the original concept of a tax-free individual savings account.
However, each new account type targets points of particular financial pain such as tuition fees, property purchase, or retirement and the new found flexibility and widened investment universe means that ISAs are a key weapon in the DIY investor’s armoury.
With subscription limits on the rise – £20,000 for tax year 2019/20 – ISAs are clearly something the government is keen to encourage, and are increasingly being seen as a viable and flexible alternative to traditional pension savings accounts.
‘ISAs are a key weapon in the DIY investor’s armoury’
A growing band of canny investors are joining the almost 1000-strong ‘ISA Millionaire’s Club’ having transferred in their PEP and TESSA assets; Fidelity International recently estimated that it would now be possible for those subscribing to the max and achieving 7% investment return, to amass a seven figure pot in just 22 years.
Soaring markets have seen the number of ISA millionaires increase rapidly with Hargreaves Lansdown having more than one hundred and Barclays 154.
Albeit that investing £20,000 a year would be something of a stretch for those on the national average wage of £27,531, it makes for good headlines and provides a benchmark for the savvy investor – ‘ISA Investing – Join the Club’.
So, before signing on the dotted – or more likely, clicking ‘accept’ – and then ruefully spending time and potentially money in unpicking the wrong choice, here is an overview of the options that exist to help you find the right ISA for you; there will be one, because tax-free savings or investment is rarely a bad idea, and accounts that allow you to choose a basket of stocks and shares or other investments give you a fighting chance of improving upon the miserly Cash ISA rates that are currently on offer.
For more information on individual product types or background information, please click the links.
The original ISA comes in two iterations – Cash ISA and Stocks and Shares ISA – which effectively put a tax-free wrapper around your savings and investments respectively, to ensure that you pay no tax on interest earned or investment returns.
You can choose whether to stay in cash or invest in stocks and shares or a mixture of both, and you have the flexibility to switch between them.
Stocks and Shares ISAs can be a packaged product, either comprising actively managed funds that seek to outperform the market or made up of ‘passive’ investments such as index trackers or Exchange Traded Funds; alternatively the DIY investor may opt for a Self-Select ISA which is essentially an empty wrapper, typically held with an execution only broker, in which their chosen portfolio of investments is sheltered.
Managed Stocks and Shares ISAs have historically returned between 6-7% although there will always be a caveat in the small print.
An increasing number of digital wealth managers – ‘robo-advisers’ – are offering ISA accounts which tax-wrap investments made into either a readymade model portfolio, or an individually risk managed account.
Each tax year, which runs from April 6th to April 5th, every individual is given an ISA allowance – the amount they can either save or invest in a tax-free wrapper; the allowance is £20,000 in tax year 2019/20.
Savers must be aged at least 16 to open a Cash ISA and investors in Stocks and Shares ISAs must be 18 or over; all must be UK resident.
Best for: Cash ISAs were launched in April 1999 to replace Tax-Exempt Special Savings Accounts (TESSAs) and Stocks and Shares ISAs to replace Personal Equity Plans (PEPs) and since then have been the mainstay for millions of UK savers and investors.
With rates low, those considering a Cash ISA should shop around, but with the flexibility to spread their investment around could consider putting some into a Stocks and Shares ISA – up to the level of their risk tolerance – in search of better returns; this may particularly appeal if they have a longer investment horizon – maybe five years plus – to reduce the potential for short-term market volatility to deliver losses.
Most products will allow regular monthly contributions and brokers such as EQi allow regular investments to be made into a selected fund or investment for just £1.50 per month.
The next generation of robo-advisers allow regular investments into a diversified investment portfolio that is selected according to your individual circumstances and attitude to risk and then constantly monitored and rebalanced according to changing market conditions – see Muckle
Introduced in November 2011 to replace the Child Trust Fund, the Junior ISA (JISA) allows up to £4,368 to be saved tax-free each year for their child; parents and carers of children under 18, born on or after January 3rd 2011 or before September 2002, can open an account. Between these dates, Child Trust Funds were granted which can be transferred into a JISA
‘Junior ISAs are a good way to give children a financial head start in life’
The JISA comes with Cash and Stocks and Shares options; money stays in the account until the child reaches age eighteen, when it becomes a Basic ISA; the child can apply to be the registered contact from the age of sixteen or can open either their own JISA or a Basic Cash ISA account.
JISAs are starting to be made available by the robo-advisers.
Best for: With tuition fees, high levels of student debt and the very high cost of accommodation, Junior ISAs are a good way to give children a financial head start in life.
There are few circumstances in which opening a JISA would be a poor choice for anyone under the age of eighteen; with a relatively long investment horizon a JISA may be the place to consider slightly more risky investments, and an ideal way to benefit from Einstein’s ‘eighth wonder of the world’ – compound interest – S=P(1+ J/N)NT….But no Chicks for Free!
An Inheritance ISA can be opened by widows, widowers and bereaved civil partners who have lost their spouse or civil partner since December 3rd 2014; it is essentially an additional ISA allowance on top of the basic £20,000 p.a.
The allowance is set at the value as your partner’s ISA as at the date of their death and it is transferred into an account in your name, with all interest, income and withdrawals preserved tax-free; before the Inheritance ISA upon the death of an ISA account holder, the account was closed and the tax-free status of the investment terminated.
For example if someone were to pass away leaving an ISA valued at £50,000, a surviving partner in the current tax year would have an ISA allowance of £70,000 – the 2019/20 annual ISA allowance of £20,000 plus an inherited allowance of £50,000.
The extra allowance is called the additional permitted subscription (APS) allowance and it is not dependant on the surviving spouse inheriting the actual money or investments held within the ISA; there are three years after death to establish an account, or 180 days after the administration of the estate is complete, if later.
Best for: The Inheritance ISA is designed to address a very specific situation and is designed for anyone whose spouse had an ISA when he or she died.
Help to Buy ISA
The Help to Buy ISA was designed to specifically target those saving for the deposit on a first property purchase; first time buyers saving up to £12,000 as a deposit for their property could benefit from a 25% ‘bonus’ up to a maximum of £3,000, giving them £15,000 to put down.
An account could be opened with an initial £1,200 lump sum and then topped up by £200 per month to which the government adds £50.
Help to Buy ISAs are no longer available, but if you opened your Help to Buy ISA before 30 November 2019, the date new applications closed, then you can keep saving into your account and earn a government bonus towards your first home.
‘a well intentioned attempt to improve an intractable impediment to youngsters getting on the property ladder’
The launch of the Help to Buy ISA was less than silky smooth after it was discovered that the bonus would only be paid upon completion of the property purchase, but it was a well intentioned attempt to improve an intractable impediment to youngsters getting on the property ladder and has problems that should prove surmountable.
The bonus can be used to buy a home costing up to £250,000 outside London or £450,000 in the capital; cash can be used for something other than a house deposit, but the 25% bonus is withdrawn.
Applicants had to be aged sixteen or over, have never owned a home here or abroad and can’t have saved more than £1,200 into a Basic ISA in the tax year in which the Help to Buy ISA is opened.
The Help to Buy ISA was a personal allowance, so joint buyers that each qualify could save up to £400 per month and receive a £100 bonus.
It is a cash account that comes with no investment risk and is covered by the Financial Services Compensation Scheme; Barclays currently tops the Help to Buy ISA best buy table, offering 2.53% p.a.
Accounts could be opened at any time up until 30th November 2019, and contributions can be made until December 2029; the bonus will be added if it is used as a deposit up until December 2030.
Best for: The Help to Buy ISA has a very specific purpose; there is little downside in opening a Help to Buy ISA – if you decide that you are not ready to buy a property or the property you plan to purchase is beyond the price threshold, you are able to withdraw funds at any time with tax free interest payments, without the government bonus, although it is this 25% addition that makes the proposition attractive.
Home buyers currently have the option of a Lifetime ISA, and it will be possible to transfer from Help to Buy into a LISA.
A flagship announcement in the 2016 Budget, the Lifetime ISA (LISA) allows anyone between the ages of eighteen and forty to save into a new, more flexible, ISA wrapper and use the proceeds to either get a foot on the housing ladder, or provide for their retirement.
‘a step closer to a Pension ISA which would harmonise the tax treatment of personal pensions and ISA wrappers’
A LISA rewards savers by contributing £1 for every £4 they put away up to a maximum of £1000 per annum; it is seen by many as a step closer to a Pension ISA which would harmonise the tax treatment of personal pensions and ISA wrappers.
The money can be withdrawn at any time to buy a house worth up to £450,000.
When a LISA is being used to save for retirement, you can make no further contributions one you reach the age of fifty and neither will you receive additional bonus payments; your pot can be accessed at age sixty but any money taken out earlier for reasons other than a house deposit loses the government bonuses and interest and growth on them, and are ‘punished’ with a 5% withdrawal fee.
The LISA is a well-intentioned and bold initiative and designed to display the government’s commitment to savings and investment; it also adds a dimension to retirement planning and some of the issues are considered here – A Pension, an ISA or a LISA?
Best for: The LISA represents a flexible proposition; younger, basic-rate taxpayers saving for a home will be attracted by the 25% boost they receive, and it is also good for those who are self-employed and do not have an employer paying into a pension for them.
There is probably not currently a ‘right’ or a ‘wrong’ in terms of retirement planning – individual circumstances will be crucial in deciding between paying ‘on the way in’ by saving taxed income in a LISA or ‘on the way out’ with a pension.
A Flexible ISA is not strictly speaking a discrete product; rather a series of features that can, or don’t have to, be applied to a Basic ISA.
Introduced in 2016 it can allow cash to be withdrawn and re-deposited it in the same tax year, without breaching overall subscription limits.
However, providers are not required to implement the flexible features so it is really about understanding what an individual provider supports; it does not have to implement them all if they allow some.
If current year money is withdrawn, that money can now be used to subscribe to a different type of ISA in the current year without having to replace it into the Flexible ISA it was withdrawn from.
Junior ISAs, Help to Buy ISAs, Lifetime ISAs and any element of a Stocks and Shares ISA that is not cash, are excluded from such flexibility.
Best for: As its title suggests, the Flexible ISA is ideal for savers who need full access to their cash; with increasing self-employment, potentially it could be used by those setting cash aside for a future tax liability but not wanting to miss out on interest.
This is not just dipping into current year subscriptions – savers can access prior year subscriptions to cover short term needs, and replace them without losing tax benefits.
Innovative Finance ISA
Launched in April 2016, the Innovative Finance ISA (IFISA) allows you to shelter your savings with marketplace, or ‘peer-to-peer’ lenders.
P2P lenders effectively cut out banks and institutions by linking lenders direct with borrowers, investors directly with companies (albeit that blockchain technology may yet add a twist to the tale) and can generate returns of between 8-9%.
This area is hot right now and something the government is keen to encourage; however, your money is not currently covered by the Financial Services Compensation Scheme if the borrower defaults or the provider collapses.
The IFISA launched with something of a whisper, as few would-be providers had achieved the requisite permissions to hit the go-live date, but there is fresh momentum in the sector as investors seeking income look for alternatives – The Quest for Income: Marketplace Lending Comes of Age.
The sector has also seen the development of a number of platforms that aggregate loans, and therefore add greater diversification and thereby spread risk more widely; many of these offer the tax efficiency of an IFISA wrapper.
Best for: Those happy to take extra risk to get a better return, and possibly keen to embrace the new dynamic.
In the first instance it would appear prudent to apportion only a part of your savings to P2P and consider spreading the rest around in Cash, Stocks and Shares buckets, but this is a sector with considerable momentum, and incapable of being ignored.
Compare IFISA here