Understanding the new ISA route map
Since they arrived in 1999, individual savings accounts have been an integral part of the UK’s financial landscape. Millions of Brits have saved thousands in tax by putting their money in ISA wrappers, whether in savings accounts or seek further growth by investing in the stockmarket.
So it seems strange that, until last month, it wasn’t possible to directly switch money from a cash ISA into a stocks and shares ISA without losing the tax benefits.
However, an overhaul in the way ISAs work now makes it easier for savers to dip into the world of stocks and shares. Many of the changes included as part of the government’s revamp of ISAs have been reported in great depth, such as the increase in the amount you can put away in a tax-free ISA to a total of £7,200, up to £3,600 of which can be held in cash.
But perhaps the more important change is that savers who have been stashing money away in cash ISAs can now transfer this money into a stocks and shares ISA. Crucially, this can be done without the money leaving the safety of the ISA wrapper or affecting the annual ISA allowance - as long as the money isn’t physically withdrawn.
It was possible to transfer cash ISAs before, but only from one ISA provider to another - for example, if you found a bank offering a better interest rate - and not from cash to stocks and shares.
Under the latest changes, however, you can now transfer some - or even all - of the cash saved into an ISA in previous tax years into a stocks and shares ISA, without fear of using up that year’s ISA allowance. You can even transfer across cash that you deposited in the current tax year - but you have to transfer the full amount. Once you’ve done so, it’s as if that cash ISA never existed.
This means that if you saved £2,000 in a cash ISA this year, then transferred it into a stocks and shares ISA, you could still put another £5,200 into ISAs that year: up to the full amount into a stocks and shares ISA or up to £3,600 into a cash ISA.
But beware - it doesn’t work the other way around; you cannot move money in a stocks and shares ISA back into a cash ISA if you change your mind again, although many in the industry are lobbying for that to change.
"As people build up a nest egg and as they become more sophisticated in their views towards the stockmarket, people who have just invested in cash in the past may see an advantage in dipping their toes into the stockmarket," says Liz Hogbin, director of savings and investments at Lloyds TSB. "So this gives them the opportunity to do that very easily with no tax penalties."
Hogbin points out that another change taking effect: people who have child trust funds (CTFs) will now be able to roll the proceeds into an ISA when they mature, without incurring any tax penalties. However, the benefits of this are unlikely to be felt until the first CTFs mature in around 15 years.
Only the names have changed
As part of the government’s ISA 2008 spring-clean, it also decided to sweep away all the confusing terminology that surrounds them. What were known as mini-cash ISAs, Tessa-only ISAs and the cash part of a maxi-ISA will now all be called, simply, cash ISAs. Mini stocks and shares ISAs, as well as the stocks and shares part of the investment vehicle formerly known as a maxi-ISA, will all now be called stocks and shares ISAs. To top it off, Personal Equity Plans (PEPs) are to be rebranded as stocks and shares ISAs too.
HM Revenue and Customs says PEP investors will get a wider range of investments to choose from under the ISA banner. However, the interest earned on uninvested cash held in what was formerly the PEP will now be taxed at 20% in the ISA, a rule that has always applied to stocks and shares ISAs. Investors may also want to consider merging existing stocks and shares ISAs with their newly rebranded PEP to help keep costs down.
It’s the new ability to transfer money from cash ISAs into stocks and shares ISAs that has been most warmly received by the experts. "I think it gives people some added flexibility," says Bob Perkins, technical manager at Origen Financial Services. "In the past if they wanted to move their money from a cash ISA to a stocks and shares ISA, they would have to come out of their cash ISA and reinvest the money. Of course the problem with that is that they’re using some of their ISA allowance," he says.
So, what’s the big deal about it becoming easier to invest in equities? Jason Britton, co-fund manager at fund of funds specialist T. Bailey, points out that as ISAs have been around now since 1999, savers could have some serious funds stashed away in cash.
"Many cautious investors may have subscribed substantial amounts into their cash ISAs - as much as £27,000. But this may not necessarily be the best thing," he says.
History shows that over the long term, equities - or stocks and shares - tend to give you a better return than cash, Britton says. Within equity ISAs you can invest in collective investments like unit trusts for example, as well as in shares listed on a recognised stock exchange and other investment vehicles such as bonds.
"So if you want growth, you are generally advised to have some money in equities. Remember too that cash is not as risk-free as many people think. Inflation can erode the value of your cash and it looks like inflation is rearing its head again, so this is relevant."
"With interest rates set to continue in a downward trend this year, savers need to seek an alternative approach if they wish to achieve returns greater than inflation over time," agrees Philip Pearson, a partner at Southampton-based IFA firm P&P Invest. "Using the equity ISA allowance can achieve this by creating a balanced portfolio designed to minimise risk whilst achieving returns better than cash over the medium term."
But, as Britton says, there are going to be many people who think it’s mad to buy equities now, as the effects of the credit crunch are felt. But he believes investors should be undeterred.
"The first rule of investment is: buy low, sell high. It sounds obvious and simple, but it isn’t," he says. "When equity prices are low it’s because fewer people want them. It can be quite uncomfortable to buy when everyone around you is panicking and saying ‘sell!’ But professional investors will be out there picking up bargains galore at the moment."
That said, it is important to understand the risks associated with investing in equities before you take the plunge. As they say, with stocks and shares the value of your investment could go down as well as up. There are also lifecycle considerations to factor in - taking a risk on equities close to retirement may not be such a good idea.
Martin Bamford, joint-managing director at IFA Informed Choice, predicts there will be a lot of "aggressive" marketing from fund managers keen to get a chunk of the new money potentially flowing across into stocks and shares ISAs. "It is important that investors aren’t swayed by the hype and rush into a decision about moving from cash to stocks and shares, particularly in the current market conditions, which are quite volatile," he says.
Perkins points out that the rationale for investing in equities is quite different to that for cash. "You invest in cash because you want to have access to the money in the short term and you can’t afford to lose it," he explains. "Whereas you invest in stocks and shares through collectives because what you want is the benefit of greater potential medium to long-term growth and you don’t actually need access to the cash," he says.
"You don’t buy collective (investments) on a whim, or to hold for 18 months to two years. You generally buy them on the basis that you’re going to hold them for at least five to seven years," Perkins adds.
"Whether or not we’re actually going to see an awful lot of people moving from what was known as the mini-cash ISA into stocks and shares I think is highly unlikely," says Phillip Wood, director of wealth advisory at accountancy firm PricewaterhouseCoopers. "I think most people who have invested into cash ISAs have done it because they want a low-risk tax efficient investment vehicle. They’ve clearly made the decision that they want cash and they don’t want stocks and shares," he says.
Transferring your allowance
But if you do want to transfer money from your cash ISA into stocks and shares, you can do this in just the same way as you would shift your cash ISA to another provider. That is, you don’t withdraw the funds and move it across yourself - or this will count against your current ISA allowance. You select who you want to have your new stocks and shares ISA with and they will arrange the transfer for you.
There is no recommended minimum amount to transfer but, according to Bamford, collective funds typically look for a minimum investment of around £1,000, although some will take as little as £500.
"But obviously, the more you can move across, the better you can create a more diversified portfolio – then you’re not reliant on just picking one or two funds," he says.
Britton suggests that those people with more than they need sitting in cash that are keen to try out the world of equities – but also a little hesitant - should consider a cautious managed fund. T Bailey’s own cautious managed fund, for instance, has no more than 60% in equities, with the rest sitting in less volatile assets like cash, bonds and property.
"Funds like this are a useful half-way house between cash and pure equities," he says.
Meanwhile, Pearson suggests making use of a platform such as that offered by Skandia Selestia. This ISA gives an investor access to more than 900 individual funds from 60 different companies, all within a single plan.
However, whatever you do, getting advice from an IFA before taking the plunge is always a smart idea.
"There are so many collective investments out there to choose from that will accept you into an ISA," says Perkins. "Do you want income or do you want growth. Do you want a mixture of the two and what other investments have you got? It’s not cut and dried - there isn’t a one-size fits all."
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.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
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).
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.