With the upcoming arrival of our first child and judging by the title, you would be forgiven for thinking that I must have babies on the brain. There is little else that Katie and I seem to be able to focus on lately! Nevertheless, this blog is all about the unfolding ISA maze, so bring a map and compass with you.
You may recall that PEPs (Personal Equity Plans) were introduced back in 1986 and TESSAs (Tax-Exempt Special Savings Accounts) were added to the mix in 1990. Then ISAs (Individual Savings Accounts) came along in 1999, replacing both PEPs and TESSAs. In 2008, we also saw the welcome removal of so-called Mini-ISAs and Maxi-ISAs, which has helped to simplify matters.
However, just as you begin to think that logic is prevailing and the ISA landscape is getting simpler, we’ve started to see complexity creeping back in with a new range of ISA options and lots of important considerations. This has gone from being a simple tax-efficient investment to a very complex regime.
What is an ISA?
ISAs are like savings accounts with added spice. Unlike ordinary savings accounts, they can grow free of both income tax and capital gains tax. In addition, any income or withdrawals are paid tax-free and ISAs can be held in cash savings or invested in stocks and shares. Also, unlike pensions, ISAs can be really flexible, helping you to adapt when things don’t go to plan.
It may not sound like much, but reducing tax and/or costs (that would otherwise be payable on your savings and investments) compounds tremendously over the years. Einstein once said that “compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” If you’d like to know more about the benefits of compounding, check out our blog: Compounding – Why 1% matters
The trade-offs with ISAs are relatively minimal; ISAs can’t be held in joint names, they can be subject to inheritance tax and there’s also a limit on how much you can save into ISAs each year (£15,240 per person for 2016/17 rising to £20,000 in 2017/18). This means that, if you sell a business or inherit a large sum of money, you can’t simply pay it all into an ISA overnight; it takes planning.
What are the different types of ISA?
The table below shows some of the key differences between the range of ISAs available:
|Type||Age||ISA allowance (2016/17)||Government bonus||Early exit penalty||Access|
|Cash ISA||16+||£15,240 pa||N/A||N/A||Age 16+|
|Stocks and Shares ISA||18+||Age 18+|
|Junior ISA||Under 18s||£4,080 pa||N/A||N/A||The child can take control at age 16 but can’t withdraw money until age 18+|
|Help to Buy ISA||16+||£200 pm||25% (£400 to £3,000)||No bonus||First-time buyers only for properties up to £250,000 (or £450,000 if buying in London)|
|Lifetime ISA*||18 to 40||£4,000 pa*||25% (up to £32,000)||No bonus and 5% charge||First-time buyers for properties up to £450,000 or age 60+ for retirement|
*Available from April 2017
As you can see, there are some important considerations here, and this is before we even begin to consider which company to use or how to invest any money in stocks and shares. However, as always, it’s crucial to understand your ‘why?’ before committing your hard-earned savings. Andrew Pereira wrote an excellent blog on this topic: What really matters is the “Why?”
Some Cash ISAs have ‘Flexible ISA’ status, which means that you can take money out at any point and return it in the same tax year without it reducing your current year’s allowance.
You may have also read about Peer-to-Peer (P2P) lending ISAs. These use money that you save into a P2P ISA to lend out to other individuals, in return for a higher rate of interest than you would expect to see in a Cash ISA with a bank or building society. However, despite the somewhat appealing interest rates, the risks are significant and P2P ISAs are not covered by the Financial Services Compensation Scheme (FSCS), so you could lose all your money. This is why we do not recommend these to our clients. To find out more about peer-to-peer lending, see our blog: Peer-to-peer lending – A fad or the future?
When it comes to Stocks and Shares ISAs, there are a number of investment options to consider. You can choose to invest in a portfolio of collective investment funds, selecting these from the many hundreds available or you can invest directly in individual shares using a so-called Self Select ISA. Either way, it’s important to understand the risks you are taking and have a suitable asset allocation that matches your intended risk-rating.
One option is investing in AIM (Alternative Investment Market) stock in a Self Select ISA. There are some inheritance tax benefits worth considering with this route, but the risks can outweigh the benefits. We often discuss with clients how there is a relationship between investment risk and reward, however, this isn’t a linear relationship and sometimes there is risk with little or no reward. Tim Hale explains this concept well here: The Good, The Bad and The Ugly of VCTs and EISs
Since April 2015, new rules were introduced that enable a surviving spouse or civil partner to inherit ISA savings, which provides a one-off additional ISA allowance, equivalent to the value of the deceased spouse’s ISA at the date of death. This is achieved by applying for an Additional Permitted Subscription (APS) allowance and then using this to make an additional contribution into their own ISA.
At Quadrant Group, we provide a holistic financial planning service, which means that our job is to assess your overall circumstances and goals and, only then, recommend which types of ISA, if any, are best for you and your needs.
Counting down the weeks, I’m anxiously anticipating that first night when we’ll get home with our new-born baby and the likely realisation of responsibility dawning upon us. Perhaps we ought to be thinking about their future and consider starting some savings? However, I would probably consider a Stakeholder Pension for our child before a Junior ISA… If you’d like to know why, please get in touch.
This article does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections.