Why investing in an Isa just got better
Isa investors put far less into cash Isas during the last tax year. According to the Bank of England, cash Isa investment plummeted, with the continuation of low interest rates almost certain to have been a key factor in the dramatic reduction in cash Isa saving.
At the same time, according to the Investment Management Association, which monitors fund investing, significantly more money was invested in stocks and shares Isas as investors sought to find higher returns on their money.
For investors who perhaps decided not to take advantage of their Isa allowance last year, simply because interest rates were so low, you may want to reconsider this year.
It is true that over a single year the benefits of an Isa are relatively limited but it is the compound effect of multiple years’ worth of contributions combined with growth that is where Isas come into their own. Being able to potentially convert a six-figure Isa into a tax-free income stream, when you need it, is not to be sniffed at.
While it is likely that strong markets certainly proved attractive for investors, alongside a search for better returns, the last-minute rush towards stocks and shares Isa investing may also be a result of the budget changes that have made Isa investing even more compelling.
The forthcoming rules, which come into effect on 1 July, allow you to transfer your stocks and shares Isa into a cash Isa. This new-found flexibility should mean that investors who had previously saved into a cash Isa, should now consider taking advantage of the potential for higher returns in the stockmarket, knowing they can transfer the entire amount to cash at any point in the future.
According to a recent survey of more than 2,000 of our Interactive Investor customers, two-thirds of Isa investors plan to use theirs to supplement their income in retirement.
Given this fact, it is perhaps no surprise that investors may have viewed cash Isas as a great long-term plan - even if they had no need for any additional cash savings at the time. The fact that you can now grow your Isa by investing in the stockmarket and then convert the entire amount into a tax-free, non-declarable income when you need it is a fantastic enhancement.
In addition, the new rules give stocks and shares investors even more flexibility on what they can invest in. Under the current system, you aren’t allowed to hold investments that appear to be too close to cash within an Isa.
However, with the new rules, investments such as short-term bonds or cash funds will now qualify. So Isa investors can now actively self-select whether to invest in very low-risk bonds or gilts, which may provide a better return on their money than cash, while also avoiding the need to transfer to a cash Isa.
Cash Isas still have a valuable part to play for most savers. They are the logical home for rainy-day money or for those who might be saving for a house or other asset. They are also a perfect vehicle for older people looking to generate a tax-free income.
In addition, if you’re a committed saver who can’t bear the idea of taking any investment risk with your money and are only interested in saving, then the new stocks and shares rules won’t necessarily appeal, though the increased allowance to £15,000 will be very welcome.
But otherwise, with the new rules in effect removing any distinction between whether you want to save or invest, and with Isas now even more flexible, Isa investing has become far more attractive.
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.
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.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.