ISA soup - just how many ISAs does a family need?


ISA soup - just how many ISAs does a family need?

There are not too many uncontroversial tax concessions, but there is no popularist clamour to abolish the Individual Savings Account or ISA. This provides a tax wrapper to remove any liability to income or capital gains tax for savings or investments held in designated accounts. According to the government web site, (https://www.gov.uk/individual-savings-accounts), there are 4 types of ISA, but then the website mentions the Junior ISA, which comes in cash and stocks & shares varieties, so I would suggest there are 6 ISAs to consider every year.

The initial 4 are:-

  • Cash ISAs

  • Stocks and Shares ISAs

  • Innovative Finance ISAs

  • Lifetime ISAs

The most you can put into any combination of the above is £20,000, (tax year 2018/19), with some specific rules around the Lifetime ISA which limit contributions in the year to £4,000. To qualify for an ISA, you need to be over 16 for a cash ISA and over 18 for all the others and under age 40 for a Lifetime ISA; you also need to be resident in the UK, or a Crown servant or their spouse or civil partner.

ISAs cannot be held jointly with anyone else or on someone else’s behalf, so they cannot be held in trust and will form part of the value of someone’s estate when they die.

So, let us consider some pros and cons for the various account types.

Cash ISA

Advantages:

  • Readily available, from high street banks, building societies, credit unions, Internet only banks, the Post Office, NS&I, (National Savings & Investment)

  • Covered by the Financial Services Compensation Scheme, so as near “safe” as anything in life.

  • Can be available in easy access and time deposit versions

  • The return will be known and predictable

Disadvantages:

  • Low returns – some providers seem to adjust their returns so that the non-ISA’ed deposit accounts have the same gross return as the ISA account. Crazily, if you are a non-taxpayer, you may be better off with an “ordinary” deposit account.

  • Account returns lag inflation, so the “real world” value of your money reduces.

  • Many are not on “flexible” terms, so withdrawals will result in a loss of ISA allowance.

Stocks and Share ISA

Advantages:

  • Readily available, from high street banks, building societies, investment platforms, financial advisers and specialist Internet sites and apps.

  • Covered by the Financial Services Compensation Scheme, so safe in terms of business failure or insolvency, but exposed to market risk for the actual investment.

  • Investments can normally be liquidated quite quickly, say 10 working days from request to cash in bank. The ISA may be flexible, so any value withdrawn during the tax year may be replenished before the year end.

  • The return can be significant and considerably more than cash on deposit terms.

Disadvantages:

  • Unpredictable investment returns with no certainty of value until sold for cash.

  • Potentially low or negative investment returns – the actual return will depend on the assets purchased within the ISA, so your capital is at risk. High risk assets ought to provide a high return but nothing is certain in life and the total loss of your capital is not impossible. Contrast the likely returns from a “Blue Chip” UK registered multinational company and a small regional business in a developing country. Please understand that your investment risk is going to be on a continuum between very little risk and a high chance of losing your capital, dependant on the actual assets purchased.

  • A widely diversified portfolio of worldwide assets should outperform cash over a longer period. Think 5 years, rather than week to week, and avoid selling assets when market conditions are poor.

  • An ISA will not have the trading flexibilities to take advantage of short term value fluctuations; it will take around 10 days to obtain value, and the market can rise or fall during that period.

  • Not all Stocks and Share ISA accounts are flexible – any value taken during the year may be lost to the ISA allowance.

Innovative Finance ISA

Advantages:

  • Higher headline return rates than cash and claimed to be more consistent than Stocks and Share ISAs

  • Investing in areas like personal loans, property purchase or business funding.

  • Terms between 1 and three years are available, depending on the provider selected.

Disadvantages:

  • NOT COVERED BY THE FINANCIAL SERVICES COMPENSATION SCHEME; you will need to do your own due diligence and must understand that your risk is to all of your capital invested.

  • This is a very young investment market and is not widely understood. Most regulated financial advisers will not offer advice on these products, so you are, very much, on your own.

  • Most, but not all Innovative Finance ISA providers offer a secondary market, so you can cash in your investment before the normal end date. There will normally be a cost to this service and there is no guarantee that you will be able to transfer all of your investments at the time you would like.

Lifetime ISA

Advantages:

  • The government will match up to £4000 paid in per year with up to £1000, (25%), for an account owner from 18 years old to 50 years of age.

  • A cash Lifetime ISA is covered by the Financial Services Compensation Scheme, so as near “safe” as anything in life. A stocks and share Lifetime ISA has the same protections as a normal Stocks and Share ISA.

  • Can be used to part fund a house for a first-time buyer or as a pension pot if withdrawn aged over 60.

  • A cash Lifetime ISA will have a return that will be known and predictable. You can transfer between providers and therefore move a cash Lifetime ISA to a Stocks and Share Lifetime ISA.

  • Parents and grandparents can pay into a Lifetime ISA, which could be a better option than a conventional ISA, as withdrawals have restrictions and penalties.

Disadvantages:

  • The ISA must be held for more than 12 months to avoid any penalties on withdrawal for house purchase. The first-time buyer status is onerous, (never having owed a house at any time), and the cap on the property cost, (£450,000), may be too low for the South East of England.

  • There are very few providers at the moment. At the time of writing, there is one cash Lifetime ISA provider and 7 stocks and share Lifetime ISAs.

  • Withdrawals not meeting the conditions of a house purchase before age 60 will incur a 25% penalty.

  • If you are employed, then you probably should not prefer a Lifetime ISA to a workplace pension for pension saving, as you would be foregoing the employer contribution. Having both is a possibility, but you will need to ensure that this would be the best solution for yourself.

As I stated earlier, you can contribute up to £20,000 into any combination of the four ISAs above in the same tax year. This means that you could put £4,000 into a cash Lifetime ISA, (the maximum) and £16,000 in any combination to a Cash, Stocks & Share and Innovative Finance ISA.

Junior ISA

Parents or guardians with parental responsibility can open a Junior ISA for their children under 18 and living in the UK. The offspring of a Crown servant, working overseas, can have a Junior ISA, so long as they depend on the Crown servant for care. Junior ISAs can be cash or stocks & shares and the annual contribution limit is £4,260 in the current tax year, (2018/19).

At age 16, the child can take over control of the account and can withdraw the money at age 18. This may be a concern for parents and grandparents, if Junior is prone to poor spending choices.

Horses for Courses

Tax concessions are few and far between, so any sustainable financial plan will consider the use of ISAs and what assets it would be best to hold the make the biggest difference. Any unused allowance is lost when the tax year changes, so if you have the resources, you should take up as much as you can.

For someone on modest earnings, a cash ISA used as a savings fund would be appropriate, but anyone with surplus cash and an expectation of not spending it for some time, say more than 5 years, should look to a stocks and share ISA.

For the young professional, a Lifetime ISA would give them access to an additional 25% of potential house purchase money. Where the likely purchase is less than 5 years away, then the Cash Lifetime ISA would appear to be appropriate, but life is never simple. Not having an emergency fund would suggest that some cash in a deposit account would be a priority, but approaching the bank of mum and dad or grandparents could be very advantageous.

For any long-term investment, some formal financial advice could save tears and tantrums later. For many people, ISAs are the first step along a long road, so give your saving and investments some structure for the future.

If you would like to know more about how we can help you plan and realise your financial goals then contact us at info@martin-redmanpartners.co.uk or call us on 01223 792 196.

The information contained is for guidance only and does not constitute financial advice. It is based on our understanding of UK legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change. Accordingly, no responsibility can be assumed by Martin-Redman Partners its officers or employees, for any loss in connection with the content hereof and any such action or inaction.