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Guide to ISAs

Recent reforms

If all the above sounds a bit complicated, take heart: since 6 April 2008, a series of reforms have made life a bit easier for investors.

Since then, the Treasury has introduced a number of simplifications:

• The Mini and Maxi ISA distinction has been scrapped – ISAs are simply cash or stocks and shares

• A £7,200 a year overall limit applies. Up to £3,600 of this can be invested in cash, with any remainder available for stocks and shares investments

• Investors are able to transfer money held in a cash ISA into a stocks and shares ISA – but not the other way around

• Existing PEPs, the old tax-free wrappers originally set up by the Tories, have been renamed as stocks and shares ISAs. This makes little practical difference to investors, in that the tax treatment for PEPs and ISAs is and remains identical. However, it simplifies administration for the fund providers

• Going forward, 18-year-olds will be able to roll their child trust funds into an ISA if they want to continue enjoying tax-free growth.

Who are ISAs good for?

Both cash and share-based ISAs are good for people who want to leave money to their descendents: the advantage of an ISA is that, unlike a pension pot, it does not have to be used to buy an annuity at age 75. This means the money can be passed on at death – although they lose their tax-free status at that point.

Cash ISAs have a range of benefits. They are good for:

• Higher-rate taxpayers, who save 40 per cent tax on their savings. They are also useful to lower-rate taxpayers. Conversely, they bring no extra benefits to non-taxpayers, who enjoy tax-free savings by filling an R85 form from their building society or bank. Basic rate taxpayers gain the most if they decide, having saved for a number of years, to take income from an ISA, especially after they have retired: this is because income is paid free of tax

• Emergency savings accounts. Most ISAs are flexible enough to allow instant encashment, although some will levy one or two months’ interest penalty for doing so

• People who have invested up to their annual pension limits. You have up to £3,600 more to tuck away each year

• People who are risk-averse: they offer a relatively risk-free tax haven for cash. ISAs are protected by the Financial Services Compensation Scheme. If a bank or building society goes bust, you get back up to 100 per cent of the first £2,000 of your savings and 90 per cent of the next £33,000, a maximum of £31,700. National Savings, one of the safest places to hold money, also offers ISAs

What should you watch out for?

• ISAs with initially-high variable rates that then move down after they have pulled in a lot of business. Financial magazines and websites publish regular updates on the “saints” and “sinners” in this area

• ISAs that are not flexible. Some will charge penalties for encashment, or even to switch from one provider to another

• If you are a non-taxpayer, they are not really worth bothering with

• If you are saving for the very long term, say 10 to 15 years or more, a cash ISA should only form a part of your overall assets. That’s because most of the time returns on cash tend to be barely above inflation levels. So if you held all your money in cash you would not see your nest egg grow that much

Stocks and shares ISAs are good for:

• People who want to see potential growth in their investments that are higher than those paid by cash savings accounts. But bear in mind that share prices can fall as well as rise and you are taking risks with your money

• People who want the possibility of both income and growth from their money. There are ISAs available that invest in a combination of fixed interest investments, such as bonds, as well as shares. This offers the chance for rising income over the years. Again, there are risks attached to such a strategy

• People who have invested up to their pension cash limits can place another £7,000 in a stocks and shares ISA. That said, the current annual investment limit into a pension is now equal to someone’s annual income, up to a maximum of £225,000, so this limit is unlikely to be breached by many

What should you watch out for with stocks & shares ISAs?

• Poor performance - many ISA fund managers deliver mediocre returns on their stock and shares-based holdings. There are all sorts of structural reasons for that, too detailed to go into here. But it is worth saying that you either need to do some research yourself or consider going to a good independent financial adviser who can recommend a suitable ISA for your needs

• High charges - a typical share-based ISA will charge up to 5 per cent of your initial investment when you put your money into it. Thereafter, it levies an annual charge, taken out of the ISA itself, which comes to an extra 1.5 per cent. In effect, the fund needs to grow by that amount, plus whatever the ongoing inflation rate is, just to stand still in terms of “real” value. Indeed, the declared charges are not the full story, as additional fees are incurred

• High risk - there is always a chance that if you are not careful, an ISA manager may take risks with your money that you might not find acceptable. Again, make sure you research the market carefully – and discuss your tolerance to risk thoroughly with your adviser.

More pages

Page 1: Introduction
Page 2: Recent reforms

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