We are fast approaching the ISA season (i.e. tax year end), and my thoughts turned towards making sure our clients maximise their allowances where possible. With this in mind, I thought I would pen some thoughts on the advantages of putting your money into an ISA, and, as there are lots of different types which one(s) should you chose?
We frequently advise clients on these questions. Simply put, an ISA (individual savings account) allows you to save money and gain interest, without it being liable to income tax.
ISAs are available to UK residents aged over 16 (except in the case of Junior ISAs). In 2018-19 you can put up to £20,000 per year into one ISA or across multiple ISAs. This limit is fixed for the financial year. Although generally, you cannot reset your limit by withdrawing money from your ISA, with some schemes you can, so not all ISA’s are equal!
Different ISAs do exist, offering certain options to the guidelines described above. So let’s briefly look at each one, with a note on some of their respective pros and cons.
Help to Buy ISA
This ISA is actually set to be phased out by November 2019. However, it is still useful to know about them in case you want to set one up before then.
Help to Buy can be an attractive saving mechanism for first-time buyers looking to save for a mortgage deposit. Under this scheme, you can save £1000 in your first month and £200 per month thereafter, tax-free.
When the time comes to putting down your mortgage deposit, the UK government will then add 25% (tax-free) to the amount in your ISA. This “bonus” is capped at £3,000.
This can be a great option for couples who are both first-time buyers, as you can both open a Help To Buy ISA. This means you could buy a house together and get up to £6,000 extra from the government as a bonus.
One downside is that the property you are looking to purchase must be valued under £250,000 (or £450,000 in London). You also need to use a solicitor when applying for the government bonus, which can be an extra cost of around £60 for an administrative fee.
Cash ISA
If you have an ordinary savings account and you have lots of money sitting in it, then you might have to pay income tax on the interest you have gained (i.e. 20% on any interest over £1,000, assuming you are a Basic Rate taxpayer).
With a Cash ISA, however, if the money was sitting in here then the interest would not be taxed. The features of this type of ISA is very similar to a typical savings account, so you are usually able to withdraw money fairly easily.
You can transfer a cash ISA (e.g. from one bank provider to another one), although this can sometimes incur a transfer penalty. Check with your provider before moving money around.
Stocks & Shares ISA
Some people want to use an ISA to save in a tax-efficient way. However, we frequently talk to people who want to use an ISA to invest – in order to attain higher returns from the interest they generate.
A Stocks & Shares ISA is one way to do this. Here, the money you put into it is invested into certain financial products. These might include funds (i.e. company shares and bonds which have been pooled together), government bonds or other investment assets.
These ISAs are attractive because they can offer a higher return than a Cash ISA, or ordinary savings account. The profits you make will not be taxed. However, your money is usually locked away for at least a few years, which limits your ability to withdraw it. Moreover, the value of your investment could go up or down depending on performance.
Innovative Finance ISA
When it comes to investing, there are different levels of risk. Investing in UK government bonds, for instance, is usually seen as fairly low-risk because the UK government is widely seen as reliable when it comes to paying its debts.
Other investments offer higher potential returns, but are inherently more risky. For instance, peer-to-peer lending (i.e. lending money to other people/companies) is regarded as in this category.
One way you can do this is via an Innovative Finance ISA, which allows you to invest in riskier opportunities without being taxed (e.g. crowdfunding and property). You should think carefully before committing large sums of money to an Innovative ISA, as this should be done within the context of a balanced, well-thought-through investment plan. Speak to one of our Oxford financial advisers if you would like to know more.
Lifetime ISA
The Lifetime ISA (or LISA) is a fairly recent scheme allowing you to save up to £4,000 a year. Whatever you put in, the UK government will add 25%. So if you put in the full £4,000 each year, you actually end up with £5,000.
The government bonus is capped at £33,000, which would actually take a long time to build up (e.g. starting your LISA at aged 18, and putting in £4,000 each year until your 50th birthday). You need to be over 18 when you open a LISA, but under the age of 40.
The main condition of a LISA is that the money must either be used for your retirement, or towards the purchase of your first home. Use it for another reason, and there would be a 25% charge – leaving you worse off than before.
Which ISAs do I need?
The answer to this question depend entirely on your own unique financial situation and goals. If you are looking to buy your first property in the next few years, for instance, then the LISA might be an option to consider. If you are over 40 and already have a mortgage, however, then this will not be open to you.
Currently, with the LISA and Help To Buy ISA both still on offer, it is worth considering which one might be better for your needs if you are looking to buy your first home soon. A big consideration here, of course, will be the value of the property you want to purchase. If it is likely to be valued over £250,000 then Help To Buy will not be suitable for you.
Regarding Cash ISA, Stocks & Shares ISAs and Innovative Finance ISAs it can really help to discuss your investment strategy with an experienced financial planner. Due to the different levels of risk and potential returns involved with each ISA, it is important to consider which option (or balance of options) might best suit your risk tolerance and financial goals.
