ON APRIL 6, at the start of every tax year, the taxman gives us the gift of a brand new Isa allowance, which is ours to use or lose. This year, that allowance is £20,000, meaning that you can save, invest or lend out this amount, and any returns you get on it won’t be taxed.
With cash saving rates so low, and the stock market in the doldrums, it can be tempting not to use the allowance. Government figures show that Isas are down from 12.7million opened in the 2015-16 financial year to 11.1million in 2016-17.
Experts warn that missing out on the allowance would be a waste. ‘It is a generous and flexible tax wrapper and there’s a good discipline in using Isas for long-term saving. The drop in numbers is a worrying gauge,’ says Justin Urquhart Stewart, who is co-founder of Seven Investment Management (7IM).
Is cash still king?
The humble Isa has come a long way since its launch in 1999. But despite the many confusingly named spin-off accounts such as the Jisa (Junior Isa), Ifisa (Innovative Finance Isa) and the Lisa (Lifetime Isa), the vast majority are still simple cash savings accounts.
Over three quarters of the Isas opened last year were in cash, but is this really the best use of your Isa allowance? Statistics from financial information group Moneyfacts show that even the best paying cash Isas have interest rates lower than the rate of inflation, meaning that your savings are losing value in real terms.
Nationwide offers an instant access Isa at 1.3 per cent, while if you want to tie your money up for five years the most you will get with cash is 2.25 per cent from Halifax. Moneyfacts’ research shows that, even this tax year, when the stock market has been subdued, most stocks and shares Isas have done far better. The average stocks and shares Isa returned 4.8 per cent while the average cash Isa has returned just 0.97 per cent.
‘Even though the 2017/18 tax year has been a more difficult environment for stocks and shares Isas, they are still outshining the returns offered by their cash equivalents,’ says Richard Eagling, head of pensions and investments at Moneyfacts. ‘It will be interesting to see whether the recent volatility in the markets dampens investor enthusiasm for this type of Isa.’
Some better alternatives
If a cash Isa no longer looks like a good bet, what might be an alternative? Some newer types might give you more bang for your buck, as long as they fit with your risk-tolerance, goals and demographic.
A Lifetime Isa
If you are under 40 and don’t own a property, a Lifetime Isa is a great way to use some of your allowance. You can only put £4,000 of your £20,000 a year into one of these, but the government will top this up by 25 per cent − a free £1,000 a year. Lisas can be in cash or in stocks and shares, and you can save into them until you are 50. You can transfer them, too, so if you aren’t happy with the returns you are getting, or interest rates rise, you can move the money between cash and investments. There’s a catch, and it’s a big one. The money in your Lisa can only be used to purchase a first home, or accessed for retirement once you hit 60. But if you haven’t yet bought a home and you want to save up for one, a Lisa is a great use of at least some of that £20,000.
Innovative Finance Isa
This is the new kid on the block. These Isas are designed to support the new craze for crowdfunding and peer-to-peer investing, where individuals lend money to businesses and individuals and reap the rewards in the form of regular payments. This type of lending has become popular with people who are horrified by the rates that they get on their savings, but who want the security of a regular payment. The money isn’t guaranteed. If the company you are lending to fails, or the individual doesn’t pay the money back, you’ll lose out. However, returns can be significantly higher than cash savings. Neil Faulkner, from Ifisa comparison site 4thway, has some tips for those just dipping their toes into the peer-to-peer lending space.
‘Innovative Finance Isas are an investment and must not be misunderstood for a typical savings account,’ he says. ‘As with all investments, by far the most essential step to reducing risks down to a sensible level is to spread money around, not putting all your eggs in one basket. Beginners might stick to platforms that have at least a few years’ history and are very open about their interest rates, and which have a record of low bad debts or great bad-debt recovery.’
He recommends residential buy-to-let site Landbay as one of the lower risk Ifisas, while if you want to select which businesses you are lending to he suggests sites such as FundingSecure, where the loans are backed by assets. Landbay gives an expected return of 3.54 per cent. Those with an interest in ethical finance, who aren’t shy about tying up their money for a while, might also look at Triodos Bank’s Ifisa. It is offering five per cent returns for 12 years to those investing in a wind turbine in the North West Highlands, for example.
Diversified Stocks And Shares Isa
A simple alternative to a cash Isa is a stocks and shares Isa, which can hold either single stocks or funds. Funds can be easier in some cases, because they offer instant diversification, with lots of different companies investment in the same fund. The performance can vary widely, and the value can go up, as well as down.
According to Moneyfacts, the best performing fund for your Isa last tax year was Jupiter’s UK Smaller Companies Fund, which grew 35 per cent on the year. Another good investment would have been a fund within the Japanese Smaller Companies sector, which rose 25.5 per cent.
‘If you don’t have a lump sum to invest, work out how much you can put away monthly at the start of the month and automate it by setting up a standing order. Above all, keep your investing costs low,’ advises independent financial adviser Carl Roberts. One of the cheapest places to buy funds in an Isa is with Vanguard, which specialises in passive index trackers. These are funds that replicate the performance of a market, such as the FTSE 100. However, you can only invest in Vanguard’s own funds through this. More varied options include Charles Stanley, which has an annual charge of just 0.25 per cent on fund holdings up to £250,000.
Sooner, rather than later
Whichever Isa you choose, there’s little sense in waiting until the last minute to put your money in. Make a plan to use your £20,000 allowance gradually over the year or as early as you can. ‘People would normally do better to make their Isa contributions at the start of the tax year rather than leaving them to the last minute,’ says Scott Gallacher, financial adviser at Rowley Turton. ‘This way they’d benefit from a whole year of extra tax free investment growth and dividends. Last minute contributions also carry the additional risk of an unfortunate postal delay meaning you accidentally miss out on utilising your Isa allowance for that tax year. Better to be the early bird rather than a potential April fool.’