Interest rates remain at rock-bottom levels, and many people are choosing to look beyond cash in an attempt to get bigger returns.
With cash Isas returning low levels of interest, stocks and shares Isas are an increasingly popular way of using your yearly tax-free allowance. By the end of the 2015/16 tax year, there was £249 billion invested in non-cash accounts, representing 48% of the total Isa market.
First launched in 1999, the stocks and shares Isa has since been joined by a range of other Isa accounts in recent times. Which Isa you choose depends on if you are saving for a home, interested in peer-to-peer lending or just looking for a better return on your cash.
Risk and reward
Stocks and shares Isas offer the prospect of higher returns than cash, although there is a greater level of risk. This kind of investment is suited to medium- and long-term investors rather than those seeking an instant return on their money.
The good news is that all the profits made in your stocks and shares Isa are tax free. Non-Isa investments are liable to an 18% tax for basic-rate payers and 28% if you’re in the higher- or additional-rate tax band, once you pass the £11,100 capital gains tax allowance.
Tax benefits for stocks and shares Isa account holders are as follows.
- Investments that pay interest (for example, government and corporate bonds), or rental income (such as some property funds) provide 100% tax-free income if held within a stocks and shares Isa and therefore offer tax benefits for everyone.
- All individuals are eligible for a £5,000 tax-free dividend allowance. Dividends received on shares within an Isa will remain tax-free and won’t impact your dividend allowance.
- Also, any profit you make when selling investments in your stocks and shares Isa is free of capital gains tax.
Rob Morgan, pensions and investments analyst at Charles Stanley, says: “The appeal of cash Isas is fading as low interest rates are hurting savers. What is more, the personal savings allowance introduced from April 2016 means that many people no longer pay tax on their savings interest in bank and building society accounts.
“With ordinary savings accounts providing similar rates in many cases, and banks now paying interest gross (untaxed) rather than net (with basic-rate tax taken off), many people are questioning the point of saving into a cash Isa and are instead looking to transfer to a stocks and shares Isa in search of superior long-term returns, albeit with higher risks attached.”
If you already have a pot of savings in a cash Isa, then it is possible to move this over to a stocks and shares product – you just need to ask the new provider for a transfer form. Don’t withdraw the cash from the Isa wrapper yourself as you’ll lose the tax advantages. But it is always a good idea to hold some cash in an easily accessible account, so consider how you want to invest and plan accordingly.
Patrick Connolly, financial planner at Chase de Vere, says: “As a starting point, you need to decide what you want to achieve, how long you are planning to invest and how much risk you are prepared to take. This will help you decide the most appropriate investments for you.
“Before investing, you should make sure that you have paid off any expensive debt and have enough money in cash to cater for any short-term emergencies or requirements.
“First time investors should usually avoid higher risk or more specialist investments, unless they fully understand the risks and are prepared to take a long-term perspective, say 10 years or more.”
Cost of investment
Investing can be a daunting task at the best of times. The FTSE 100 index of the biggest companies listed on the London Stock Exchange may have reached record highs this year, but the UK’s exit from the European Union and the long-term impact of President Trump present challenges.
To counter any short-term fluctuations, you can choose to drip-feed money into your chosen investments at regular intervals. This means you’re not risking all of your cash at one moment in time and your risk is spread over a longer period.
Mr Morgan says: “The stock market has performed very well recently, and that may put some people who are worried about buying in at the peak of the market off.
“However, the prevailing level of the market should never really put you off investing – so long as you make investing a habit and commit for the longer term, the peaks and troughs have a tendency to pale into insignificance over time.”
There is a wide range of choice when it comes to stocks and shares Isas. You can hold individual company shares, bonds or funds. Funds are holdings, which are run by professionals who pool together a number of investments. Your portfolio can cover everything from individual firms to full sectors and this allows the risk to be spread over multiple asset classes.
It is also important to remember the costs associated with this kind of investment and any ongoing dealing charges. An independent financial adviser will tend to deal with people who are investing larger sums of £50,000 or more so smaller investors must typically fend for themselves.
Most investors tend to use platforms – examples include Charles Stanley Direct, Hargreaves Lansdown or Interactive Investor (Moneywise’s parent company). These charge either a yearly fee –usually a percentage of your Isa’s value – or a fixed amount which is charged each time you make a trade.
“When buying funds through an Isa on a low-cost platform, the charges (fund annual charge and annual platform fee) are usually percentage rather than fixed ones so starting to invest with a small amount is perfectly valid,” says Mr Morgan. “A lump sum of £1,000 is one way to start – or you could commit to investing regularly from £50 per month.”
Don’t forget the other kinds of Isa
A range of new Isa accounts has been launched in recent years to cater for specific segments of the market.
The Help to Buy Isa gives aspiring homeowners assistance when buying their first home and pays a bonus once a purchase is completed.
Rates on offer are much higher than the equivalent cash Isa – the current top paying account generally available to all is from Barclays at a rate of 2.27% - but there are some restrictions. You can only pay in £200 a month, plus an extra £1,000 when you open the account. This means the total maximum saved is £3,400 in the first year and £2,400 in each subsequent year.
A bonus of 25% is paid when the account owner buys a house. The maximum bonus awarded through the scheme is £3,000 and is paid upon completion, which means it can be used for the mortgage deposit, but not for the exchange deposit and any costs incurred prior to completion.
This is only available to people who have never owned a home before, although couples may hold separate Isas and thus both can benefit from a government bonus.
Meanwhile, peer-to-peer (P2P) investments can now be held in a tax-free Isa for the first time after the launch of the Innovative Finance Isa – sometimes known as an Ifisa – in April 2016. This offers higher returns but is much riskier than other kinds of investment. The range of providers is relatively small at present with Crowdstacker and Crowd2Fund some of the bigger names in the market.
While peer-to-peer investors have seen strong returns, so far there are doubts about the long-term sustainability of the market. Mr Connolly believes this is a much riskier option than investing in stocks and shares.
“Accounts that offer higher returns typically come with more risk and, as the peer-to-peer market continues to grow and develop, we are likely to see new entrants entering the fray,” he says.
“While more competition should be positive news for consumers, with it comes increased risks that all providers might not be of suitable quality.
“You can invest up to £20,000 in Innovative Finance Isas in the 2017/18 tax year. While peer-to-peer lending is now regulated by the Financial Conduct Authority, it still isn’t covered by the Financial Services Compensation Scheme, so if a borrower or provider defaults those who invest could be left out of pocket.”
Lifetime Isas will launch in April 2017 and are an option for people saving for a first home or for their retirement. The Junior Isa is also an option for younger savers.