Each tax year, savers can use all their annual ISA allowance but, even after 25 years, there’s still confusion about how this tax-efficient saving system works.
There are so many Isa-labelled products with numerous rules and restrictions. It can be a minefield trying to fathom out what you can invest in, and when – it’s too much for many people to get their heads round.
So, what do you need to know when it comes to this important form of tax-efficient saving / investing?
How it works
An Isa (individual savings account) allows you to save money without having to pay tax on what you make on it. This could be the interest accrued, or the income from investments you make through it.
Every year there’s a maximum amount you can save into an Isa – this tax year it’s £20,000. There are 5 different types of account – cash, stocks and shares, lifetime, innovative finance, and junior.
You can split the allowance between them, apart from the junior one, for which there’s a separate £9,000 allowance. If you don’t invest by the end of the tax year, the allowance expires and a new one starts on 6 April.
There’s been criticism in the past that the system is overly complicated and confusing (surprise, surprise!), for example, that there are too many names for Isa products.
There have been moves to make the system simpler. Next year you’ll be able to sign up to several Isas of the same type (such as cash) instead of just one, which is the current rule. Labour has said it will simplify Isas further.
Understanding the different limits, allowances and tax implications can be challenging but at the heart of the Isa is a straightforward tax wrapper. Once you dip your toe in, you realise they’re far simpler than the alternative because there’s no horrible tax-return admin to worry about.
Cash Savings
Cash Isas were once dismissed due to low interest rates. But the last 18 months have seen rates surge.
Latest figures from financial data site Moneyfacts show some pretty good rates of interest on Isas, especially if you’re willing to lock the money away for 12 or 24 months.
In the past, savers have questioned whether it is worth investing in a cash Isa following the introduction of the personal savings allowance (PSA), which means basic-rate taxpayers don’t pay tax on the first £1,000 of interest, and higher-rate taxpayers on the first £500.
But the better rates of late have meant many savers will now potentially face a tax bill for their investment, arguably making cash Isas a lot more worthwhile.
If you’re offered the same rate on an Isa account and a non-Isa account, chances are it makes sense to opt for the cash Isa.
That’s because the PSA could be withdrawn, or cut, at some future point. Or you may simply find yourself with more cash interest, which uses up the limit.
Now interest rates are higher, tax on savings is becoming much more of a problem, so cash Isas shouldn’t be sniffed at. The difficulty comes when you get a lower rate on a cash Isa than a savings account, which is quite common.
Stocks & Shares
This year is the 25th anniversary of the introduction of the Isa. History has shown that investing in stocks and shares is the long-term winner when it comes to returns. Cash savings are better for the short term – generally less than 5 years.
Figures show that a £1,000 investment in a global tracker fund – which tracks a selection of stocks – made 25 years ago would be worth £4,094 today. The average cash Isa would have returned £1,864 over the same period, it says.
However, investors in stocks and shares Isas will have to weather the ups and downs of the stock market, which means they should be prepared for long-term investment.
The key is to give your money ample time in the market to smooth out the effects of weekly market ups and downs. And don’t forget that cash rates fluctuate, too. There’s no telling if a good rate now will still be there in the future.
Lot’s To Think About
Who thought little old Isas could be so confusing. That’s the world of financial services. My world can make even the simplest concept incredibly complicated. It drives me mad!
In a nutshell, it makes a lot of sense to be using your annual Isa allowance. There aren’t many ways to put money away without having to pay tax on the returns so it could pay to grab them while you can.
As ever, you know where I am if you have any questions. Feel free to get in touch.
See you soon!