Ensure your ISA suits your age
ISAs have clearly established themselves as a key element of the UK's personal finance furniture.
The figures speak for themselves: November 2009's gross stocks and shares ISA sales of £987 million (excluding redemptions) were the highest ever monthly sales achieved outside of the end-of-tax-year ISA season in March and April, according to the Investment Management Association.
Their run of popularity has been fuelled by the recent bull market, but ISAs are well-liked for other reasons too: their unrestricted time frame, flexibility and simplicity, as well as the tax shelter they offer.
So it's hardly surprising financial advisers consider ISAs a core part of the financial planning armoury for clients of all ages whatever their investment goals.
Investors in their 20s and 30s
Retirement seems a long way away to young savers, and there's little incentive to make provision for it when there are other more pressing calls on their limited resources.
Emergencies (mending the car, for instance), holidays, deposits on a home, a wedding - any or all are likely to seem more pressing issues.
Also, many younger savers are nervous about investing in the stockmarket, and are relatively unlikely to take professional advice, so it's hardly surprising that most favour simple, safe cash ISAs, where they can access their money when they need it.
"Cash is the obvious choice when the investment is likely to be needed within three to five years - you wouldn't want to put your money into the stockmarket for such a short length of time because if markets turned against you there would not be time for your investment to recover," explains Martin Bamford, managing director of IFA firm Informed Choice.
However, canny young investors may decide to split their ISA contributions between short-term cash and a stocks and shares investment for the medium term.
"Retirement planning is not on the radar, but young parents, for instance, may start to think about investing for their children's school or university fees," continues Bamford.
"I've found that many prefer using stocks and shares ISAs to build up an investment for their children because they can retain control of it and won't be faced with the scary prospect of having to hand over thousands of pounds to a bolshy 18-year-old tearaway, as they would have to do with a child trust fund."
Anna Sofat, managing director of IFA firm Addidi, adds that usually it's easiest for 20-somethings to save from their earnings on a monthly basis.
"We typically see contributions of £100 to £250 a month, although it's possible to save as little as £50 a month into many ISAs," she says.
Investors in their 40s and 50s
By the time they reach their 40s and 50s, investors tend to view their ISAs as simply one element of an overall investment portfolio, says Alan Dick, managing director of Forty Two Wealth Management.
"My job is partly about minimising tax liabilities on that portfolio so I would always recommend they make full use of their ISAs."
ISAs are particularly tax-efficient for cash and fixed-interest investments because gains are completely free of tax; in contrast, equity-based ISAs are still subject to a 10% tax on dividend income.
However, they do make sense for higher-rate taxpayers because these investors would otherwise have to pay an additional 22.5% tax on dividend earnings held outside the tax wrapper.
Moreover, for long-term investments and larger amounts an ISA wrapper offers valuable protection against capital gains tax when you do eventually cash your investment in.
That could be especially significant looking ahead, as the government may well raise the current 18% capital gains tax rate as a way to recoup some of its massive deficit, says Dick.
"In that case, the tax shelter provided by ISAs will be all the more valuable for long-term equity investors," he adds.
Sofat says that middle-aged investors do indeed tend to shift their focus much more towards stocks and shares ISA investments than their younger counterparts. "In part, they are thinking about significant expenses in the medium term - in particular, school fees and also, in some cases, a deposit on a second home," she says.
But by now retirement is also much less of an unimaginable event. Many make use of their ISA allowance as a flexible retirement planning tool, says Bamford.
"They aim to build up their investment as a cash cushion for retirement, but they also have in the back of their mind that it could act as a cash safety net for a 'super-emergency' if the worst happened," he explains.
That potential flexibility is a huge benefit in long-term investment: advisers are agreed that it always makes sense to put as much as you can into your ISA before starting to top up your pension.
As people come to the end of their working lives, ISAs really come into their own as a flexible pension supplement. Its big strength is that the proceeds are tax-free (unlike pension income).
That means ISA income can be drawn alongside income from pensions, but because it doesn't count as taxable income it will not push them into a higher tax bracket.
Nor, once they reach the age of 65, will it impact on the size of their age-related personal (tax-free) allowance, which stands at £9,490 for the 2009-2010 tax year and will remain unchanged for 2010-11.
Typically, says Bamford, investors reorganise their ISA portfolio to produce an income.
They may make use of this by withdrawing a fixed sum each month, or simply by taking the various bits of income generated by different holdings; some go so far as to surrender the whole investment and use the capital to supplement their pension.
One strategy is to use your pension to cover core essentials and keep your ISA income (or capital) to pay for special treats, holidays and one-off necessities such as a new car or boiler.
However, Bamford says that many people, if their pension is enough to comfortably maintain their keep, simply leave their ISA on the back burner and reinvest the income. "That can go on for decades - maybe until they need care, or even until they die," he comments.
An alternative strategy, suggested by Sofat, is to cash in some of your ISA holdings shortly before retirement, and pay the cash into your pension as a lump sum.
By doing so you receive upfront tax relief (at 40% if you're a higher-rate taxpayer). And provided you're over 50 (55 from 6 April) you can withdraw a cash lump sum of up to 25% of the pension pot.
Ultimately, the ability to shelter your money from tax within a range of assets, and then access it at any time, makes the ISA an invaluable financial planning tool.
But be aware that you need to exercise self-discipline if you're saving for the long term or for specific goals because that wonderful easy-access set-up makes it all too easy to raid your piggy-bank.
Case study - Sorting out Florence's finances
Florence is a financially savvy 30-year-old lawyer. She is earning a decent income, has cleared her student debt, and has saved enough to put down a deposit on a flat with her boyfriend. Now she wants to start investing regularly for the longer term in a stocks and shares ISA and is looking for some investment ideas.
Anna Sofat: "I'd suggest putting 70% into equities through cheap and cheerful tracker funds such as those from L&G: I'd put 50% in a UK fund, with the rest split between the US, Far East and Europe. Around 20% should go into a property fund such as the New Star or Aviva offerings and the last 10% into a bond fund."
Martin Bamford: "I'd use a mix, including First State Global Emerging Market Leaders. It invests in quite risky sectors, but for a younger person with a long-time horizon making regular investments, risk is not necessarily a bad thing.
I'd also suggest Jupiter Merlin Income Portfolio, which uses well-known funds to access a range of assets including company shares and fixed interest. Income could be reinvested for capital growth."
Adrian Lowcock, senior investment adviser at IFA firm Bestinvest: "She should look to diversify her portfolio from the outset through a global fund such as Threadneedle Global Select C1.
She could complement this with a strategic bond fund such as L&G Dynamic, plus some exposure to commercial property - maybe New Star UK Property.
By using regular savings she can put a monthly minimum of £50 into either one or all the funds; once a reasonable sum has been built up she should review the contributions and consider adding other funds."
This article was originally published in Money Observer - Moneywise's sister publication - in March 2010
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
A bull market describes a market where the prevailing trend is upward moving or “bullish”. This is a prolonged period in which investment prices rise faster than their historical average. Bull markets are characterised by optimism, investor confidence and expectations that strong results will continue. Bull markets can happen as a result of an economic recovery, an economic boom, or investor irrationality. It is the opposite of a bear market.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.