Individual Savings Accounts (ISAs) remain an important building block in helping create capital and income for the future and since their launch in 1999, when they replaced Personal Equity Plans (PEPs) and Tax-Exempt Special Savings Accounts (TESSAs), the popular personal finance vehicle has gone some way to address the shortcomings in the UK’s savings culture.
And without doubt, ISAs have proved a success story, with more than £443 billion invested over the last 15 years, of which a record £57 billion was subscribed in the last tax year (source: HMRC, September 2013). The opportunity to invest in a tax-efficient way has made ISAs the cornerstone of many investment strategies; both savers and investors are understandably enticed by the ability to achieve tax-free interest and no further tax on income or capital gains.
There are two types of ISA: Cash ISAs are savings accounts where the interest is paid tax-free, and Stocks & Shares ISAs which, as the name suggests, allow investment into a wider range of stock market and other financial instruments. However, there are restrictions on how much can be invested in each type. The full annual allowance of £11,520 (2013/14) can be invested in a Stocks & Shares ISA, but only half – £5,760 – can be saved in a Cash ISA (although the balance of the allowance can still be invested in a Stocks & Shares version). An inflation-linked increase will see the allowance rise to £11,880 in the new tax year.
An individual or couple who invested the full ISA allowance each year could by now have sheltered funds of £124,080 and £248,160 respectively from any further tax liability, according to HMRC.
But there is a sting in the tail. The squeeze on savers from record-low interest rates is also being felt by those with Cash ISAs. Figures from the Bank of England in December showed that the average Cash ISA deposit rate is just 0.67%.
The reality is that the tax benefits provided by ISAs are best maximised by investing for the long term in assets capable of achieving capital growth and rising income. The likelihood is that interest rates will remain low for a number of years to come and, regrettably, savers cannot even be sure that their Cash ISA account is achieving a better rate than a standard deposit account. Against that backdrop, whilst cash is certainly the right home for money that might be needed in the short term, ISA allowances might be better utilised by investing in a diversified portfolio of assets that have the scope to deliver higher levels of income and long-term capital gains and, in doing so, make the most of the tax freedom on returns. Of course, investors need to bear in mind that the value of a Stocks & Shares ISA may fall as well as rise and it does not provide the security of capital associated with a Cash ISA.
As well as considering the best use of this and future years’ ISA allowances, those who have already built up significant ISA funds might be able to improve the income and capital returns on offer. All too often, people do not review their ISA portfolio strategy frequently enough. How are the investment managers performing? Is the asset mix, geographic spread or fund choice still right for them? Can they improve the income-generating potential of their ISA portfolio? Are they happy with the service they’re receiving?
A thorough review of an ISA portfolio by an experienced wealth manager can ensure that it is appropriately structured and diversified to help achieve immediate or future financial goals. ISAs should be a fundamental element of financial planning, but it is also important to consider them in the context of an overall investment strategy and to ensure that an ISA portfolio can be adjusted easily to cater for changing needs.
As a final thought, parents, grandparents, and indeed anyone who might want to help a child build capital for his or her future, should not overlook Junior ISAs, which were introduced in November 2011 to give under-18s a similar tax-efficient savings opportunity. The limit for investment in this tax year is £3,600; but given the future financial challenges faced by the children of today, any help will provide them with a valued head start.
Remember that the favourable tax treatment given to ISAs is subject to changes in legislation and may not necessarily be maintained in future.
To receive a complimentary guide covering wealth management, retirement planning or Inheritance Tax planning, produced by St. James’s Place Wealth Management, contact Adam Giles of Giles Wealth Planning on 0115 8708 251 or email firstname.lastname@example.org.