04th May 2017
Different Types of ISA: Which One is Right for You?
It’s estimated that 80% of the 12.5 million ISAs that have been opened are cash ISAs, and there’s a very good reason why they’re so popular: with a cash ISA, you don’t pay tax on the interest you earn. This makes cash ISAs an attractive option for anyone who normally pays tax on their savings, and it’s one of the main reasons why they’re the best way for most people to save money. And although the new Personal Savings Allowance (PSA) means that all basic rate taxpayers will now earn £1,000 interest from all savings without being taxed on it, cash ISAs are still worth considering as the cash saved within them will be tax-free indefinitely.
UK residents aged 16 or over are entitled to open a cash ISA, and from April 2017 the annual limit for all ISAs combined is £20,000 (up from £15,240 the previous year). At the beginning of each tax year (6 April) you’ll receive a new ISA allowance. If you don’t use it, you’ll lose it – your ISA allowance can’t be rolled over to the next tax year. You may invest your full ISA allowance in cash, stocks and shares, innovative finance or a combination of any of the different types of ISA available. You can also switch your ISAs to take advantage of higher interest rates.
Determining whether or not a cash ISA is right for you depends largely on the amount of cash you have to invest. If your total savings are less than the total cash ISA allowance, the new PSA means that there’s likely to be no tax benefit to putting your money in an ISA compared to a normal savings account. If you have more savings than the cash ISA allowance, high interest current accounts are likely to be the best place for your money as, purely on interest, they’re far superior to cash ISAs. However, if interest rates increase (and the PSA doesn’t cover all your interest) you could lose out in the short term. If you have significant savings, putting/keeping some money in a cash ISA is a good idea, as it will protect you from future tax liabilities should interest rates rise.
If you don’t mind taking a few risks with your money and you have the time to ride out any market fluctuations, putting some money into a tax-efficient stocks and shares ISA could be a smart move. There’s a huge range to choose from, and you don’t even have to invest in stocks and shares – you can invest in bonds, government gilts, commercial property and even commodities such as gold.
Anybody over the age of 18 can hold a stocks and shares ISA, and you can switch to an alternative provider if you find a better deal elsewhere. ISA providers are legally obliged to permit transfers out but do not have to accept transfers in, so check with your preferred ISA provider before beginning the transfer process. It is worthwhile noting that if you are investing in stocks and shares that there may be a slight delay in accessing your funds due to having to sell some investments compared to withdrawing money from an instant access Cash ISA. Many investment experts recommend you invest for a minimum of five years in order to maximise the return on your investment.
Any investment in the stock market should be seen as a long-term proposition, and it’s vital that you understand the risks before building an investment portfolio. The value of your investment - and the income derived from it - can go down as well as up and you may get back less than you originally invested. If you feel unable to tie up your money for five years or more, or if you can’t bear the prospect of getting back less than you paid in, a cash ISA or savings account is almost certainly more suitable for you.
There are a number of different ways for parents to invest and save for their children, and one of the most popular ways is by putting money into a Junior ISA. Unlike standard accounts (where any income or savings investment above £100 per year from money derived from either parent is taxable at that parent’s tax rate), Junior ISAs offer a tax-free way for parents to save for their children up to the age of 18. The annual limits are much lower than on the basic cash ISA: at present, no more than £4,080 can be put into a Junior ISA each tax year.
Control of the money in a Junior ISA passes to the nominated child the moment they turn 16, but no withdrawals can be made until their 18th birthday (unless the child is terminally ill). At this point, the junior ISA converts to a basic adult ISA and the child can do whatever they want with the money. As with basic adult ISAs, the junior ISA allowance can be split between cash or stocks and shares, and like adult ISAs can also be transferred at any time. However, due to the long-term nature of junior ISAs, investments are a better option - unless you're risk averse and don’t want to risk losing any money.
Before deciding to put money into a junior ISA, parents should consider the restrictions in place for this type of account. You can’t have a child trust fund and a junior ISA (unless you are transferring the child trust fund into the junior ISA), and although the total amount in the ISA could potentially reach £105,357 by the time the child reaches 18 (assuming a 5% annual return and 0.75% in fees), it must be remembered that no money can be withdrawn from the account for 18 years. For that reason, junior ISAs are only recommended in cases where the parents (or child) will have no need to access that money for a significant period of time.
Launched in April 2017, the lifetime ISA is a government initiative to encourage people to save for their first home or their retirement. For every £4 you save, the government will add £1 (worth up to £1,000 a year) paid at the end of each tax year, up to the age of 50. Up to £4,000 a year is eligible for the government bonus, with the government adding a 25% bonus (up to £1,000 each year) on any contributions made before your 50th birthday.
Lifetime ISAs are available to all UK residents aged 18-39 (if you turn 40 on or before 6 April 2017 you won’t be eligible). The amount you save contributes towards your £20,000 ISA allowance, and you can only open one lifetime ISA each tax year. You can move money from an existing ISA into your lifetime ISA, and any money you transfer from your previous years’ allowance will not affect your overall ISA limit for that year. Your spouse or civil partner can inherit the value of your lifetime ISA as an “additional permitted subscription” (APS) allowance.
As well as being restricted to people under 40, lifetime ISAs are designed for two very specific scenarios: to purchase a first property or withdraw after you reach the age of 60. If you want to spend the money on something other than a property and you’re under the age of 60, you’ll be hit with a 25% penalty (after April 2018). Lifetime ISAs are certainly not for everyone, and if you think you may need to use the money for a purpose other than that which the ISA is designed for, you’re probably better off investing your money elsewhere.
Another option for first-time buyers saving for a mortgage deposit is a help to buy ISA. With a help to buy ISA you can earn up to 2.27%interest tax free, and the government will add 25% tax free to whatever is in your ISA when you use it to buy a home. However, the bonus will only be available on homes costing under £250,000 (£450,000 in London). In addition, although you can use the help to buy ISA with any type of mortgage (not just a help to buy mortgage), it must be a residential mortgage and not buy-to-let.
Before considering putting money into a help to buy ISA, you should be aware that a flaw in the scheme means that the 25% government “bonus” will not be paid out until the sale of the property has been completed. Many experts believe this renders help to buy ISAs useless as they’re designed to help first time buyers who are struggling to find the huge initial outlay to buy a home. The scheme has attracted a lot of criticism over the fact the bonus can’t be used to help pay for the deposit, and this loophole is likely to mean that many buyers will still need assistance from their parents in order to pay the deposit.
The growing popularity of alternative savings and investments schemes, such as peer-to-peer loans and crowdfunding services, has led to the government creating a new ISA category: the Innovative Finance ISA. Launched in April 2016, innovative finance ISAs are a half-way house between a cash ISA, which is safe but yields a low return, and a stocks and shares ISA, which offers more reward but carries far greater risk. Put simply, innovative finance ISAs enable you to lend out your own money – a bit like being your own bank manager.
So how exactly does it work? Peer-to-peer lending is essentially a scheme that matches borrowers with investors. Your investment is pooled with those of other investors and lent out to a number of borrowers. They pay the money back over a period of time with added interest, and you receive the interest they pay, minus any costs involved. The number and type of borrower you can lend money to will vary between peer-to-peer lenders, but they’re usually individuals looking to borrow cash for a new car or house extension. Some peer-to-peer lenders such as Funding Circle only offer finance to businesses, while others such as RateSetter offer both businesses and individuals access to investors’ money.
If all goes according to plan, the people or businesses you lend to will pay you your money back over time, with interest. Investors who are able to commit the full ISA amount for a five-year lock-in period could potentially earn up to £914 a year interest. However, while some investors see the scheme as a relatively safe way to invest money, many are fiercely critical of the ISA, such as Lord Turner, the former chief of the Financial Services Authority. Shortly before the introduction of innovative finance ISAs, Lord Turner appeared on BBC Radio 4 and predicted that there would be huge losses for peer-to-peer lenders over the next five to ten years – losses that would make banks look like “lending geniuses”. Ultimately, if your borrowers cannot keep up repayments, you will, in theory, lose your money. And unlike cash ISAs, your money will not be protected by the Financial Services Compensation Scheme (FSCS).
Inheritance ISAs are aimed at people whose partners had an ISA at the time of their death. The value of their combined ISA
accounts at the time they died is added to your own ISA allowance. For example, if your partner had £20,000 in ISAs when they passed away, you would receive an additional ISA allowance of £20,000, giving you a total allowance of £40,000. Inheritance ISAs are available to anyone who has lost a husband, wife or civil partner since December 3, 2014. The additional allowance is available for three years after your partner has passed away, or 180 days after the administration of the estate has been completed (whichever is the later date). You can’t replace any money you take out; you can only use up your remaining allowance and you may only register your inherited ISA allowance with one provider.
The inheritance ISA – or additional permitted subscription (APS) as it is sometimes known – is not dependent on the surviving spouse inheriting the actual money or investments held within their partner’s ISA. In addition, the APS allowance can be used with the ISA provider of the deceased or it can be transferred to another ISA provider, subject to the other ISA provider’s terms and conditions. However, inheritance ISAs can only be transferred once and only where no subscriptions have been made under the allowance.
While some ISA providers will allow the spouse to make regular payments, some will only allow a one-off lump sum payment. Unlike cash ISAs, stocks and shares ISAs, innovative finance ISAs and many other types of independent savings accounts, inheritance ISAs are not limited to UK residents. If someone has moved abroad but their spouse held an ISA in the UK when they died, the surviving spouse is entitled to claim the APS allowance. The APS allowance cannot be transferred to another person and it’s only to be used by the spouse or civil partner of the deceased. It does not apply to Junior ISAs or Child Trust Funds.
Flexible ISAs are not new products; they’re a new way in which some ISAs work. In a nutshell, with a flexible ISA you can take money out of your cash ISA and return it in the same tax year without reducing your annual allowance. Flexible ISAs will become “flexible” automatically – you don’t need to do anything in order to get the additional benefits of flexible withdrawals and payments. Both variable and fixed rate cash ISAs can become flexible ISAs – although not all flexible ISA providers offer flexibility on all their products.
As an example, if you have £50,000 in your cash ISA which is made up of £40,000 from previous years and £10,000 from money deposited in the current tax year, you can still deposit a further £10,000 in the current tax year (taking you up to the £20,000 threshold). With a flexible ISA, if you withdraw £10,000 you can put in another £20,000 in this tax year: the £10,000 you took out, plus the remaining £10,000 ISA allowance.
In contrast, if you withdraw money from a non-flexible ISA and replace it, the money you put back reduces your allowance for the tax year in which you replenish it. Using the above scenario as an example, if you took £10,000 out of a non-flexible ISA you would only be able to pay in £10,000 as that would mean you have paid in £10,000 in the current tax year.
There are a huge range of ISAs to choose from, and not all ISAs are created equal so it definitely pays to shop around for the best rate. If you need any help or advice with on choosing the right ISA for you, or you need help with investment management in general, please get in touch.
The information contained in this document is provided for information purposes only. Investors should form their own view in relation to the above mentioned investments. If you’re unsure of the suitability of any investment please contact us for advice. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your initial investment.