ISAs – Know Your Options

It’s April! This means not only is it officially the beginning of spring but also on the 6th of April it will be the start of a brand new tax year. For those of you who have been paying attention, you may already be aware that this tax year signals the start of two key items for savers:

  • an increased Individual Savings Account (ISA) allowance to £20,000;
  • the launch of the Lifetime ISA (LISA).

This means savers have more choice and flexibility on where to stash our money for long term returns. So where exactly should you be saving and / or investing your hard earned cash?

To kick off, it’s probably worth summarising what exactly an ISA is and why we love them so much. Put simply, ISAs are way to save tax-free indefinitely. Unlike your average, every day savings or investment account, ISA accounts are not subject to tax on its interest, income or capital gains. So, let’s say your everyday savings account offers 2% interest on your total balance. After tax, that probably means you’ll receive 1.6% if you’re a basic rate tax payer. However, if you save in an ISA you’re guaranteed the full 2% interest. That’s an extra £80 a year on £20,000 if saved in an ISA.

That’s the simplest way to explain it. How that manifests on an individual basis with the new tax on savings rules is for another blog post or read more on it here.

By increasing the allowance, we are able to save more money tax free than ever before.  Combine that with the relaxation of ISA rules a couple of years ago, and you now have up to £20,000 that can be stashed away into any one, two, or all, of the below in a financial year:

  • Cash ISA (savings account offered by your average Bank or Building Society e.g. Santander)
  • Stocks and Shares ISA (investment accounts e.g. Nutmeg, Scalable Capital, Hargreaves Lansdown)
  • Innovative Finance ISA (specifically for peer-to-peer lending platforms like Ratesetter)
  • Help to Buy ISA (ends December 2019)
  • and the newbie, the Lifetime ISA (can be cash or stocks and shares)

Note – you can split your allowance across the different ISAs available BUT you cannot open or pay into two of the same type of ISA account in a financial year. For example, if I open a Cash ISA with HSBC on Friday, I cannot then open or pay into a cash ISA with Natwest on Saturday. I can however, open a stocks and shares ISA with Nutmeg and an innovative finance ISA with Ratesetter. And of course I can now also open a LISA too.

With choice comes great responsibility. It is all well and good having options, but which one of the above is the best option?

Cash ISA

In an ideal world, we would all have £20,000 spare and available to save. Unfortunately that is not the case for a majority of us so we have to choose wisely where to put our money and what will provide us the best returns for our needs. If you follow me on twitter, you’ve probably seen me downplay cash ISAs a couple of times. Do not get me wrong, cash ISAs are usually a great way to save because they are tax free. However, in today’s current economic climate (today being 2017), there are a more regular savings accounts that offer a considerably higher rate of interest than a cash ISA, making the benefit of a tax free account next to negligible. For example, the top cash ISA available offers an interest rate of 1.95%. In comparison, the Tesco Current Account offers 3% interest on balances up to £3,000. Also, with the new tax on savings rules a basic rate tax-payer (20%) can earn up to £1,000 from their savings without paying interest (but like I said, for another post).

Stocks and Shares ISA

In contrast, a stocks and shares ISA offers the chance of higher returns. This comes with risk and is more suited for longer terms i.e. over 5 years at least. The value of your portfolio can go down as well as up (but note you only lose money when you sell!).  Do bear in mind that with Brexit and Trump, there is a level of uncertainty in the market, so understandably some people are wary of putting any eggs into this basket until the dust settles. Nevertheless there are investment options such as Nutmeg available which will do the hard work of managing your portfolio so you do not have to know the ‘ins and outs’ of the stock market to stay winning.

Source: Nutmeg.com; estimating value of £20,000 in a cash ISA compared to a Stocks & Shares ISA.

Innovative Finance ISA

The innovative finance ISA is arguably the riskiest option available. Peer-to-peer lending platforms such as Ratesetter and Zopa, enable you to lend out your money to individuals or companies looking for loans. By cutting out the middle man, you (the lender) are able to earn good interest on your money. However, this is not a savings or an investment account. You know that usual line you see about your money being protected by the Financial Services Compensation Scheme (FSCS)?  That is not the case for peer-to-peer lending websites; your money is not protected in this way. And although borrowers are credit checked and screened, there remains the risk that the money you lend out will not be paid in full i.e. if the site you use crashes and burns tomorrow, you will still be owed money. This may sound scary, understandably so and scaring people off an investment choice is not what I want to do so if it helps please remember these platforms are regulated by the Financial Conduct Authority (FCA), and there is an expectation that if a borrower were to default, the platform will be able to pay you, the lender, with no hesitation.

Help to Buy ISA

Then you have the Help to Buy ISAs. They do exactly what they say on the tin: they are there to help you buy your first house. The government will add 25% to your savings which totals up to £3,000 on £12,000 saved. By December 2019 you will no longer be able to open a Help to Buy ISA but you can still use the money for a deposit for your first house up until 2030. The introduction of the LISA is a replacement to this option and you can transfer your Help to Buy ISA balance to a LISA if you prefer. However before you click that transfer button, know that unlike the LISA, you can take money out of your Help to Buy without having to pay a penalty.

Lifetime ISA

Last but not least is the LISA; the newest option we have. So new, I almost don’t have an opinion on it. Almost. On the surface, the LISA sounds amazing; for every £4,000 you save a year, the government will give you £1,000 on top. This is separate to the interest the money will be generating on side. Too good to be true? Maybe, because the LISA can only be used for the purchase of your first house (up to the value of £450,000) or for retirement (when you’re over the age of 60). If you try to use the money for anything other than a house to live in (rules are blurry as to what happens if you want to rent that property out…) or if the house value is more than £450,000 then you’ll be subject to a 25% penalty for taking that money out. That is 25% of the money you saved; not what the government gave you. It is also important to note that not a lot of financial institutions have announced a LISA yet. Currently, only Nutmeg and Hargreaves Lansdown have officially announced a LISA offering starting in April 2017.

The answer? It all depends on you, your needs and your risk appetite.

These options may seem daunting but the key thing is to do your research. Think about what is best suited for you in the long run. Hedge your bets by choosing more than one option. And if it all seems too much, do yourself a favour and get a nice high interest rate savings account (3% or above) and re-visit this next year. We have until April 2018 to stash away £20,000. Let’s get saving.

Please note that examples used are not recommendations and are only used for reference purposes.

Please also be assured the above information provided does not in any way constitute as an investment recommendation. We advise anyone interested in the above products and services to read through their terms and conditions thoroughly and contact a financial advisor before making an investment decision regarding the products and services.

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