Changes to how savings are taxed means ISAs (Individual Savings Accounts) may not be as attractive as they once were. However, there are still plenty of reasons why ISAs should be part of your financial plan.
ISAs were first introduced 20 years ago in a bid to encourage more people to save. An ISA is essentially a tax-efficient wrapper for your savings. You don’t pay tax on the interest or returns generated within an ISA. Over the years there have been new ISA products introduced, which may offer additional incentives to save. You can either choose a Cash ISA, which will pay interest, or a Stocks and Shares ISA, where your deposits will be invested.
Since their introduction, the ISA allowance has gradually increased. You can currently place up to £20,000 into ISAs each tax year. This allowance may be used for a single ISA or spread across several accounts. If you don’t use your ISA allowance by the end of the tax year, you lose it.
Why are ISAs less attractive now?
ISAs remain popular products; official statistics show that around 10.8 million adult ISA accounts were subscribed to in 2017/18. However, this is down from 11.1 million during the previous tax year.
One of the reasons for this is the introduction of the Personal Savings Allowance (PSA). Introduced in 2016, the PSA means individuals can earn up to £1,000 in interest tax-free if they’re a basic rate taxpayer or £500 if they’re a higher rate taxpayer. For those saving using a cash account, it may mean that using an ISA has lost one of the main benefits.
Complexity around choosing an ISA product may also mean the saving vehicle is falling out of favour. This is an issue that’s been highlighted by AJ Bell, with the investment platform calling for the rules around ISAs to be simplified.
In a letter to the new Chancellor Sajid Javid, Andy Bell, Chief Executive of AJ Bell, states: ISAs started life as a very simple, tax-efficient savings products. Over the years, various changes and additions to the products have made them unnecessarily complicated, with at least six variations in existence depending on how you look at it. People now have to choose which ISA suits their specific needs and often they can’t decide, which leads to them doing nothing and not saving.
We believe a much simpler system, based around a single ISA product would mean that the only decision people need to make is to open an ISA and start saving.
So, why should you still make an ISA part of your financial plan?
1. Take advantage of tax-free interest and returns
Whilst the PSA means this advantage isn’t as appealing as it once was, it’ll still be attractive for many people.
First, if you’re an additional rate taxpayer, you don’t benefit from the PSA. As a result, an ISA can provide you with a tax-efficient place to deposit your cash savings. Even if you’re a basic or higher rate taxpayer, depending on your level of savings, you may find you exceed the PSA. An ISA can boost how much you can earn in interest tax-free.
Secondly, the PSA does not cover investments. In contrast, investing through a Stocks and Shares ISA can deliver returns that are free from Capital Gains Tax.
2. Potentially access additional bonuses
As well as offering interest and returns on deposits, some ISAs may offer additional bonuses. These aren’t available to everyone and may not match your saving goals. However, if you’re saving for your first home or retirement, they are worth considering.
The Help to Buy ISA is available for all aspiring first-time buyers. It offers a government bonus of 25% on deposits. You can open an account with up to £1,200 and can contribute up to £200 each month. You can add up to £12,000 to a Help to Buy ISA, leading to a maximum bonus of £3,000. You apply for the bonus when you’re at the point of buying a property. Help to Buy ISAs are a type of Cash ISA, so you receive interest.
A Lifetime ISA (LISA) may be an option if you’re saving for a first home or retirement. Each tax year, you can place up to £4,000 into a LISA, receiving a 25% bonus. You must be aged between 18 and 40 to open a LISA, and can continue to pay into it until you turn 50. This means the maximum bonus available is £33,000. The bonus is applied at the end of each month. A LISA can either be a Cash or Stocks and Shares account. However, there are some restrictions to keep in mind. Should you make a withdrawal before the age of 60 for a purpose other than buying your first home, you’ll lose the bonus and may get back less than you paid in.
3. Start investing with small amounts
If you want to start investing, a Stocks and Shares ISA can be a good starting point. You won’t have to pay tax on the returns generated and there are multiple options to suit how hands-on you want to be. A Stocks and Shares ISA may be right for you if you want to gradually grow your investment portfolio by adding regular, smaller sums over the long term.
For beginner investors and those that want a more hands-off approach, there are platforms that will make investment decisions for you. You’ll usually be asked some questions relating to your attitude to risk, investment goals and what you can afford to invest.
If you’re confident making investment decisions, you can choose your own investments that will be held within an ISA wrapper. You’ll need to take responsibility for researching investments, building a portfolio and keeping track of performance, as well as aligning decisions with your financial plan.
4. Shop around for the best interest rate
For the last decade, interest rates have been low. It may mean that your cash savings are struggling to keep up with inflation, effectively decreasing in value in real terms. Saving into an ISA doesn’t automatically mean you’ll access better rates, but it’s worth including them when you’re shopping around. Typically, a fixed rate ISA, where your money is locked away for a defined period of time, will offer the best returns.
Remember, if you don’t use your ISA allowance, you will lose it. If you’d like to discuss why it should be part of your financial plan and how it fits in with other options, please contact us.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.