Types of ISA accounts 2018
The UK government wants us all to save for our future. And one of the ways it is encouraging us to do so is by pushing the individual savings account (ISA). There have never been so many different types of ISA, and the annual tax-free limit per individual is a whopping £20,000.
The overall annual ISA allowance of £20,000 can be spread across the various ISA types. Back in 2009, the allowance was a mere £7200, only half of which could be in a cash ISA.
New ISA types include the innovative finance ISA, which is modelled on the stocks and shares ISA but is not widely offered by ISA providers. Then there’s the junior ISA, the help to buy ISA and its successor - the new lifetime ISA. These new ISA types bear no relation to the originals, as they are medium or long-term vehicles with tight restrictions. The inheritance ISA, meanwhile, enables the tax free wrapper to be passed on at death.
The rationale for the cash ISA, which still accounted for over 80% of all ISAs opened in 2017, has been partly undermined by the new personal savings allowance. This allowance means a basic rate tax payer doesn’t have to pay tax on the first £1000 of income from savings, while a higher rate tax payer doesn’t pay on the first £500 of savings income. That has helped boost demand for the stocks and shares ISA, which was opened in record numbers in 2017.
What is the best type of ISA for me?
There’s no simple answer for which ISA is best for you. It depends on your circumstances, how old you are, and whether you’re saving for a house deposit or not.
You also still need to consider the choice between the cash ISA and the stocks and shares ISA. Do you want a risk-free account where your savings may actually be dwindling over time as long as interest rates remain below the rate of inflation? Or are you prepared to take the risk that you may not get back what you put in, but where returns have historically been strong over longer time periods?
Stocks and shares ISA
The stocks and shares ISA, also known as an equity ISA, has been given added lustre in the coming year by the new UK tax treatment of dividends. After creating new tax rates for dividends, but granting an annual allowance of £5000, the government has now slashed that perk to just £2000 from April 2018. So an historic portfolio earning around 3% will start paying tax on dividends once it hits £66,000, unless it is safely wrapped in an ISA. Otherwise, a higher rate taxpayer will be stung with a 32.5% dividend tax. It’s 38.1% for those on the top rate of tax, while for basic rate taxpayers it is 7.5%.
There are now two ways of investing in a stocks and shares ISA. You can pick a product that allows you to choose the shares for your ISA yourself, or you could choose a product that creates a fully managed portfolio for you based on your risk profile
If you do choose to create your own ISA portfolio, where should you invest? You should try to structure your ISA portfolio so you have included different geographies, types of asset, sectors of the economy, and size of companies. If this is a long-term savings plan, you can move up the risk scale and target emerging markets, or futuristic themes.
Peter Askew, chief executive of T. Bailey Asset Management, says: ‘A portfolio of stocks invested across some of today’s big themes – robotics , automation and artificial intelligence included – is likely to deliver a return which is greater and more durable than funds investing in the developed markets’.
Some brokers are reporting a jump in the number of investors making regular monthly payments into their ISA, rather than big lump sums. At a time when markets have been highly valued and are now showing signs of renewed volatility, it makes sense to drip your savings into the market as this will smooth out the ups and downs of prices.
The personal savings allowance now enables basic rate taxpayers to earn £1000 of tax free interest and higher rate payers £500. That means there’s less of an incentive to take out a cash ISA. At the time of writing, cash ISA interest rates remain very low and below the rate of inflation, meaning your pot is actually dwindling in real terms. You may be able to achieve higher rates for cash savings outside the ISAs and still keep the income tax-free.
‘The new allowance has pretty much killed off the cash ISA,’ says Andrew Hagger, founder of the MoneyComms site. Indeed, the amount held in cash ISAs fell by a third in 2016-17. One big broker reports that 40% of all its transfers are coming from cash ISAs.
In theory, you can replace cash withdrawn from a cash ISA during the year without reducing that year’s annual ISA allowance. However, not all ISA providers actually offer this so-called flexible ISA.
Innovative finance ISA
Just £17 million from 2000 investors was put into the new innovative finance ISA in its first year, after the UK government gave the peer-to-peer (P2P) lending sector its stamp of approval in 2016. After a regulatory logjam, there are now 30 platforms offering ISAs. But many are new and untried, while many of the more reassuring, longer-established platforms have had to restrict ISAs to existing customers. Zopa, for example, has a waiting list. But if you are prepared to stomach the risk, returns starting at 4% to 6% and rising into double figures for higher-risk loans are on offer. But don’t expect instant or even easy access. The advantage of the innovative finance ISA wrapper is that interest from P2P lending is not covered by the personal savings allowance.
This is only for buying your first home or saving for later life. You can save up to £4000 a year up to age 50, with the government paying a 25% bonus every year. But if you touch the fund, other than for property purchase or at age 60, you’ll pay a 25% penalty. A good way to complement a workplace pension, or create one if you’re self-employed.
Help to buy ISA
Available until 30 November 2019 for first-time buyers to save up to £12,000 and get a 25% bonus from the government. The lifetime ISA then takes over, though existing help to buy ISAs will run until 2030.
No government bonus here, but a way to designate a long-term savings pot to a child. Up to £3600 can be invested each year, returns are tax free, and the final fund is turned over to the child when they reach 18. This tax wrapper makes sense for stocks and shares, as it’s a longer-term timeframe.
Maike Currie, investment director at Fidelity International, recommends considering a ‘set and forget’ fund such as a low-cost, global exchange traded fund (ETF) or tracker fund.
This is actually an allowance which can be claimed by a spouse or civil partner, enabling them to inherit their partner’s ISAs up to three years after their partner’s death.
You can only have one cash ISA, one stocks and shares ISA and one innovative finance ISA running in any tax year. Once open, you can transfer money between them freely, subject to providers’ terms.
Within a tax year you can transfer an entire ISA to a new provider. You may be able to transfer all or parts of ISAs built up in previous years, depending on provider rules.
Never close an ISA if you want to switch providers. Wait for the existing account to be transferred or you will lose the wrapper.