From 1 July the Individual Savings Account (ISA) will be replaced by the ‘New ISA’, or ‘NISA’ with an increased annual allowance of £15,000, which can be divided any way you like between cash and shares. The new vehicle will remove unnecessary complexity and give tax-incentivised investors much greater flexibility when investing their savings.
Whether you continue to hold a Cash ISA, Stocks & Shares ISA or open a NISA, all three will serve the same purpose of helping you build a nest egg for that dream holiday, second home, children’s school fees or to support a decent standard of living in retirement.
With interest rates still at record lows, the levels of interest available on cash deposits are struggling to outpace inflation which creates an extra spur for savers to deploy their cash into the market though a tax-efficient vehicle.
All the interest and dividends on ISA holdings are free of income tax, minus the 10% tax credit on dividends which is deducted at source and cannot be reclaimed. There can be additional tax on dividends from foreign-domiciled business, of which you can reclaim a portion.
Any growth from capital appreciation is free of capital gains tax (CGT). The only real downside is any losses incurred on investments made within an ISA cannot be offset against CGT on gains from investments made outside the wrapper.
As Fidelity’s head of corporate and investment writing Tom Stevenson says: ‘If you invest through an ISA you never have to worry about income tax or CGT ever again - and crucially you don’t have to tell the taxman about investments in your tax return.’
A life less limited
Commenting on the imminent changes to the ISA Redmayne Bentley stockbroker Lauren Charnley says: ‘This will be positive for investors and savers as ISAs will become simple, flexible and generous savings vehicles ensuring you’re in control of how and where you save your money.’
Barclays Stockbrokers’ vice president Catherine Penney is equally enthused: ‘An ISA enables investors to build a tax efficient shelter year by year, brick by brick....and the bricks are getting bigger.’ Fidelity’s Stevenson adds: ‘This is a pretty significant rise per individual and for a couple an annual allowance of £30,000 means pretty much everyone will have more than enough headroom in their ISA to hold all their savings tax free. And of course the increase in the Junior ISA allowance to £4,000 offers additional amount as well.’
Although the limits may seem beyond the savings ambitions of many and the current CGT allowance of £11,000 might also appear more than sufficient, Stevenson explains these thresholds could become increasingly relevant over time. ‘For many people an £11,000 gain in a year is implausible but if you invest in ISAs over the years you can build up a very significant sum which outside an ISA could see you start to incur CGT.’
Penney backs up this endorsement of the ISA’s long-term appeal. ‘The real power of ISAs becomes evident when looking at those who have regularly used their allowance to build a portfolio protected from tax. Through ISAs, investors could have contributed up to £135,960 since they launched in 1999. So, while the protection from tax means that investments have the potential to grow faster year on year, the longer-term benefit of tax free income is even more compelling.
‘Regular contributions to an ISA can provide a savings pot to supplement pension with tax-free income. This is why even when times are tough investors should still consider investing in ISAs, though it is important for them to bear in mind the risks of loss of capital, and that the value of this favourable tax treatment of ISAs to an individual will depend on that person’s individual circumstances.’
Charles Galbraith, managing director of AJ Bell Youinvest, notes the creation of the NISA is just the latest development in a long tradition of successive governments supporting the tax wrapper: ‘The ISA allowance has been indexed up each year, unlike pension allowances, and the government also introduced a Junior ISA in 2011. All this points to long-term support of ISAs as a saving vehicle. So it would seem unlikely that the government would radically cut back on something that has such popularity, particularly considering the current savings challenge.’
Increased flexibility
A Stocks & Shares ISA allows you to buy and sell from a long list of permitted assets including: UK and overseas shares; managed funds; exchange-traded funds; government bonds, or Gilts; corporate bonds and from July 2014 peer-to-peer loans. Another change in July is the inclusion of short-dated bonds - previously securities had to have a maturity of five years or more to be included in an ISA. See page 52 for a full list of the different assets which are eligible. Remember not all brokers offer the full investment choice, so it is worth checking before you open an account.
‘You can include a wide range of qualifying investments and in fact the rules have loosened here too,’ explains Fidelity’s Stevenson. ‘You can hold shares and funds, AIM-quoted shares, and from July peer-to-peer loans and short-dated bonds.’
And as the expert points out, from 5 August 2013 it has been possible to include shares quoted on the London Stock Exchange’s (LSE) Alternative Investment Market (AIM) in an ISA. Previously this had not been possible except in cases where a company had a listing on another ‘recognised’ stock exchange.
Galbraith confirms that appetite has been strong for AIM shares from his company’s clients: ‘This has become very popular amongst AJ Bell Youinvest customers - nearly 10% of investments within our ISAs are now in AIM shares. This change is also very valuable for smaller companies who are listed on AIM as their shares can be held by a large pool of investors.’
AIM is usually seen as being more volatile and higher risk than the Main Market. Because, generally speaking, less people trade AIM shares it can be harder to buy and sell them. AIM companies can often have greater exposure to a single product or service, can be overly reliant on their founder or chief executive officer (CEO) or can be over-exposed to one geographic region.
This means that if something goes wrong in the particular area in which they are operating or if their CEO decides to leave for pastures new, they can be particularly vulnerable. They should therefore only be considered by sophisticated investors who have a long-term investment horizon, understand the risks and can accept that the value of their investments can fall as well as rise.
The latest Halifax Share Dealing Market Tracker survey shows 29% of investors are planning to invest more in Stocks & Shares ISAs when the allowance increases next month but only around 10% are likely to move their money between cash and investments during the year. Under the current set-up you can only move funds from a Cash ISA into a Stocks & Shares ISA and not the other way round but the NISA allows you to switch freely between cash and shares - something which appears to not yet be fully recognised by investors.
Charles Stanley’s pensions and investments analyst Rob Morgan says this under-appreciated feature of the NISA could be a real boon: ‘I think it is going to be very useful. Where previously you could only move cash into the market you now have the opportunity to move back and forth. Someone who is approaching retirement and wants to de-risk their portfolio might want to use the facility to cash out. On the face of it the change looks pretty innocuous but it is in fact a significant change and we hope providers make it easy to switch between the two.’
Penney says: ‘The greater choice of asset classes that can be held within a Stocks & Shares ISA means that an ISA could truly be a lifetime account. It allows portfolios to evolve over time - increasing the risk profile as investors become more confident and then moving to less risky investments or even cash as they become older and are likely to be less risk tolerant.’
Fidelity’s Stevenson also thinks this could be a positive development but warns it may lead to excessive caution among savers. Previously in order to make use of your full ISA allowance at least some of your capital had to be in a Stocks & Shares ISA. ‘It is a bit of a double-edged sword - many people’s instinct may be go into cash because it feels safer but over any extended period you will generate much better returns from shares than cash.’
Choosing a provider
Opening an ISA means choosing a product and provider which best suits your investment goals. If you decide to open a Stocks & Shares ISA you need to think carefully about whether or not you will have sufficient time to manage a portfolio yourself. If you do then a full-blown self-select ISA - essentially an execution-only broking account within a tax-efficient wrapper - is the way to go.
Many of the charges associated with an ISA are the same as you would pay for saving or investing outside of the tax wrapper. A Cash ISA, for example, is no different, barring its tax-efficient status, from any other bank or building society account. The only relevant charges here can be penalties for early withdrawal, transfer or closure fees.
When it comes to a Stocks & Shares ISA, the same applies. Whether held within an ISA or not, actively-managed funds usually include an initial charge in the 3% to 5% range, with annual management fees of 1% to 1.5% and a levy for switching between different funds. Those lacking the time or desire to engage in stock picking could consider a less complex and potentially cheaper product which offers exposure to a limited basket of funds.
A straightforward approach is to opt for a ‘managed’ fund. This would invest in a mix of assets with allocation dependent on the risk profile of the investor. The industry body for fund management groups - the Investment Management Association - splits managed funds into three separate categories: Cautious, Balanced and Active. The asset mix varies between lower-risk options, such as cash and bonds, and high-risk ones, such as stocks and shares (namely equities) and you can choose which one best suits your desired return and appetite for risk. An ISA which provides access to a wider selection of funds as well as some of the larger UK-listed stocks could be a good halfway house for anyone who sits between these two camps.
As AJ Bell Youinvest’s Galbraith drives home, it is always important to clearly establish your requirements before embarking on any selection process: ‘The first thing to consider is what you are looking to invest in - shares, ETFs, funds, etc? and then create a shortlist of providers that offer access to those investments. Once you’ve established that shortlist you can then drill down into how each provider’s fees will work in relation to your investment plans - issues like how often you will deal and whether your portfolio will mainly be made up of shares, funds or ETFs will have an impact on exactly how much each provider will cost.’
Halifax Share Dealing’s head of customer services and dealing Andrew Raby says: ‘Stocks & Shares ISAs won’t be for everybody as your capital is at risk. People also have to decide if they want access to the whole market or a limited range of funds. For some customers a simple ISA with just a few funds will be great but for others the whole of market is absolutely what they want. ‘
Stevenson at Fidelity explains there are four things investors should consider when choosing a provider: ‘Number one is cost - though for a number of platforms, including Fidelity’s, there is no additional cost associated with an ISA wrapper at all. If there is a cost attached to the wrapper then that is something to consider.
‘Second is the level of service you get from a provider. Are you prepared to do everything online or are you looking to have someone on the other end of the phone? How easy is it to switch?
‘Thirdly I would look at the level of information that the provider gives you. Are you getting the information and guidance you need to make the right decisions?’
‘Last is the range of investments and here you should think about what you’re likely to take advantage of. After all you do not want to pay for flexibility or services you are not going to use.’
As Barclays’ Penney points out it is still unclear exactly how providers will react to the NISA changes: ‘The changes announced in the budget were welcome but surprising. Providers were given a short period to implement the initial announcement. Therefore we expect that many Stocks & Shares ISA providers will have enhanced their range of investments for 1 July, but will seek to improve their propositions further over the coming months.
‘We are also keen to see the distinction between the two types of ISA disappear to give investors even greater flexibility. However this will take time to realise from both a regulatory and a systems perspective and though we aren’t expecting imminent changes; any that are, favourable or unfavourable, can be applied to the NISA rules at any time.’
If you have several ISAs in place from previous years, you can choose to move them all to a single provider. Your new provider will deal with the process of gathering the various funds into one account for you. Such a move will allow you to consolidate all of your existing ISA funds in one place. Remember you will lose your tax benefits if you withdraw the money from the account. Instead the new provider should provide you with a transfer form which typically includes a note you can send to your existing ISA provider. The new company should then be able to arrange matters for you, transfer the money and keep the tax benefits intact.
According to HM Revenue & Customs if you move savings from a Cash ISA to another Cash ISA the process must usually be completed within 15 business days of you requesting it. A transfer between a Cash ISA and Stocks & Shares ISA or between different Stocks & Shares ISAs must usually be completed within 30 days of you putting in your request.
Future changes
The sweeping reforms of the past 12 months show it is worth monitoring changes in the set-up for ISAs. These are typically introduced in the Budget in March or revealed in the chancellor’s Autumn Statement.
Redmayne’s Charnley says: ‘The recent changes are likely to remain in place for some time, although investors should not completely rule out the potential for future changes, as the government of course has the ability to tinker with ISAs as it sees fit.’
Stevenson feels the ISA limits will continue to increase from £15,000. ‘I think it will continue to rise in line with inflation. If you compare it to the limits associated with PEPs (Personal Equity Plans - the predecessor to the ISA) in the late 80s and early 90s then on an inflation-adjusted basis £15,000 doesn’t look too generous. It is a popular vehicle and it will be politically expedient to keep bumping up the allowance.’
What can be included in THE NEW FORMAT ISA
- Cash
- Shares and securities in investment trusts or companies
- Corporate bonds
- UK government bonds
- Units or shares in funds authorised by the Financial Conduct Authority (FCA) such as unit trusts or open-ended investment companies (Oeics)
- Shares issued by companies listed on a recognised overseas exchange
- Units or shares in Undertakings for Collective Investment in Transferable Securities (UCITS) funds. These are funds based in the European Union that are similar to authorised unit trusts and Oeics
- Units or shares in non-UCITS schemes authorised by the FCA for sale to retail investors in the UK
- Shares which have been transferred from an HM Revenue & Customs-approved employee share scheme, such as a Save As You Earn share option or Share Incentive Plan
- Qualifying life insurance policies
- Stakeholder medium-term products
- Exchange-traded Funds
- Exchange-traded Commodities
- Peer-to-peer loans
