As we head towards the end of the tax year when the bulk of investors make their ISA contributions, Laith Khalaf, head of investment analysis at AJ Bell, looks at the six different ISAs available to investors right now:
“The ISA is 25 years old, but since the good old days of Maxi and Mini ISAs, there have been a number of additions to the ISA family, and happily a large increase to the ISA allowance, which started life as £7,000 for a Stocks and Shares ISA, and now stands at £20,000. While the ISA has been a big success, it’s fair to say with six different ISAs to choose from, savers and investors now need to pause for thought before filling their boots. To help them along here’s some pointers on how each ISA can be used to meet particular financial goals.”
Stocks & Shares ISAs
“The Stocks and Shares ISA is a tax-efficient and flexible wrapper which you can use to grow your wealth and protect it from inflation. It can be used for a variety of longer-term investment goals, such as saving for school or university fees, to pay off a mortgage, or to boost your retirement fund. There are a wide range of investments you can choose from, including funds, shares, investment trusts, bonds and cash, so this ISA can be calibrated to your tolerance for risk and your appetite for growth. Using your stocks and shares ISA allowance to shelter your investments has never been more important because the government is taking an axe to tax-free dividend and CGT allowances. The annual dividend allowance is being cut from £2,000 last year to £1,000 this year and £500 next year, and the CGT allowance is being cut from £12,300 last year to £6,000 this year and £3,000 next year.”
Stocks and Shares ISAs are well suited to:
- Saving for retirement (a ‘side car’ for your pension)
- Saving for school/university fees
- Saving to pay off a mortgage
- Saving to build up financial resilience in the medium/long term
- A home for tax-free cash lump sums drawn from pensions
- Saving over and above short-term spending needs
Cash ISAs
“Cash ISAs have been much maligned of late, ever since their raison d’être was undermined by the introduction of the Personal Savings Allowance, which allows basic rate taxpayers to receive £1,000 of interest tax-free every year. Higher rate taxpayers can only receive £500 of annual interest before paying tax though, and additional rate taxpayers pay tax on all their interest. Add in the fact that Cash ISAs often pay a bit less interest than a savings account, and it’s easy to see why they may have fallen down the priority list.
“But higher interest rates have led to a dramatic reassessment of the value of Cash ISAs. A recent FOI request made by AJ Bell to HMRC showed that over 2.7 million people are expected to pay interest on their savings this year, up by a million in a single year. That figure includes 1.4 million basic rate taxpayers, who may have hitherto shunned Cash ISAs because ultra-low interest rates meant they had a slim chance of breaching the £1,000 Personal Savings Allowance.
“Cash ISAs are not very flexible in that they can only ever hold cash, but this does make them good for storing money that you might need at the drop of a hat. That’s because the value of your Cash ISA will never fall, unlike a stocks and shares ISA, though over time it may be vulnerable to the effects of inflation, if prices are rising faster than the interest rate your Cash ISA is paying. For longer-term savings Cash ISAs are likely to provide lower returns than a Stocks and Shares ISA. Data from the Barclays Equity Gilt study shows that over a ten year period, UK shares have a 91% chance of beating cash.”
Cash ISAs are well suited to:
- Building up a rainy day fund
- Saving for short-term spending needs (with the money needed in the next five years or so)
- Long-term saving for the ultra-cautious who don’t wish to see any fall in the nominal value of their money, even if that means falling behind inflation
Lifetime ISAs
“The Lifetime ISA is a fairly new addition to the ISA family and comes in stocks and shares and cash flavours. The attraction of this ISA is the government bonus of 25%, up to a maximum of £1,000 a year. This comes with strings attached though. The ISA can only be used to fund a first house purchase, or else drawn after the age of 60, otherwise there is a penalty for withdrawal. This makes the Lifetime ISA appropriate for those saving up for a house deposit or for retirement. It’s also an ISA for younger people because it comes with age restrictions. Only those between 18 and 50 can contribute, and they must have set up the account by the age of 40. Higher earners and those who aren’t maximising employer pension contributions might be better off adding more to their pension rather than saving in a Lifetime ISA though, if they are using it to fund their retirement.”
Lifetime ISAs are well-suited to:
- Saving for retirement
- Saving for a house deposit
IF you meet the age criteria
Junior ISAs
“Junior ISAs allow parents, grandparents or anyone else who feels inclined to contribute to an ISA for a child, up to £9,000 a year. The child can start to manage the JISA from age 16 and gets access to it from age 18, so it can be used to help them through university, travel during a gap year, or go towards a house deposit. There are both cash and stocks and shares Junior ISAs available, with many parents opting for the cash option. However, given the long-term investment horizon most children would have, it makes a lot of sense for parents to consider the stocks and shares route. There is currently a bit of a loophole in the rules which means children between the age of 16 and 18 can apply for a £9,000 Junior ISA and a £20,000 adult cash ISA at the same time, providing them with a potential ISA contribution of £29,000 in total, the biggest allowance anyone at any age receives. This loophole is being closed from 5 April this year when the minimum age to open a Cash ISA will be raised from 16 to 18.”
Junior ISAs are well-suited to:
- Saving for university fees and costs
- Saving for a gap year
- Saving for a first house deposit
- Giving young adults a head start and an understanding of the benefits of saving
Innovative Finance ISAs
“The Innovative Finance ISA was launched to help provide a boost to the peer-to-leer lending industry, but it now looks like a busted flush. HMRC figures show that last year these accounted for only 0.13% of ISAs contributed to, so they are a really niche product, and are likely to become even less appealing now savers can get more reasonable rates from traditional savings accounts, including Cash ISAs. If you are interested in peer-to-peer lending and want to protect your interest from tax though, an Innovative Finance ISA can help.”
Innovative Finance ISAs are well-suited to:
- Those who invest in peer-to-peer lending products and wish to shelter their interest from tax
Help to Buy ISAs
“The final product in the ISA line-up is the Help to Buy ISA. This was initially set up to provide a 25% government top up for first time buyers saving for a house deposit. Unlike the Lifetime ISA you can only pay in £200 a month, so an annual total of £2,400 rather than £4,000, and there is a cap on the total government top up of £3,000. However, the Help to Buy ISA has now been superseded by the Lifetime ISA, and you can no longer open one, though if you already have one you can still contribute until 2029.”
You might save into an existing Help to Buy ISA over a Lifetime ISA if you already have one open AND
- You don’t have a Lifetime ISA already and plan to buy a house in the next 12 months – this is the length of time a Lifetime ISA account needs to be open before you can claim the bonus to buy a house
- You fall outside the age limits for a Lifetime ISA
BUT
- Outside of London your house purchase is capped at £250,000 rather than £450,000 for the Lifetime ISA
- The purchase must be made by 30 November 2030 to receive the bonus
- You are limited to a maximum saving of £12,000 in a Help to Buy ISA
- You can’t claim a bonus on the Help to Buy ISA if saving for retirement
