For those looking to make the most out of their cash, investment Isas – known as Stocks and Shares and Innovative Finance Isas – offer greater potential. However, you need to be able to take a risk.
Cash Isas have long been the first stop for savers looking for a tax-free return on their money. However, thanks to strong stock market performance in recent years, there is now more money held in Stocks and Shares Isas than their cash equivalents.
Data from HMRC shows that of the £585 billion held in adult Isa accounts at the end of the 2016/17 tax year, 54% of this value was held in Stocks and Shares Isas.
Additionally, research by Foresters Friendly Society shows that consumers are increasingly looking to Isas to save for the long term. Some 35% of people say they are prioritising a long-term, rainy-day fund over other financial milestones, while 29% say they are looking towards retirement.
This means investment Isas, which should be considered as a medium- to long-term option for your cash, could be a solution.
Why use an Isa?
A Stocks and Shares Isa is a popular way to invest because it offers tax-free returns to investors and, as with a Cash Isa, you can add up to £20,000 each tax year.
Plus, while some of the tax advantages of saving within an Isa have diminished for cash savers, for investors there are many benefits to saving in this tax-free way.
Largely, this is because you are not liable to pay tax regardless of how you earn from your investments.
There are three key ways this can help individuals pay less tax. Firstly, investments that pay interest, such as government and corporate bonds, or rental income, such as some property funds, will generate taxfree income if held within a Stocks and Shares Isa.
For those who receive a dividend on their investment, an upcoming tax change also makes it more beneficial to use an Isa. The annual tax-free dividend allowance for investments not held within an Isa will be slashed to £2,000 for the 2018/19 tax year, down from a £5,000 annual allowance.
However, all dividends generated by a Stocks and Shares Isa will be tax free, regardless of how big they are.
The final tax benefit is that you are not liable to pay any capital gains tax (CGT) on your investment growth. Once you pass the annual capital gains tax allowance – £11,300 in the 2017/18 tax year, rising to £11,700 in 2018/19 – you are normally liable to pay tax on the amount your investments have increased in value since you bought them.
Non-Isa investments, excluding residential property where higher rates apply, are liable to a 10% CGT for basic-rate payers and 20% if you’re in the higher- or additional-rate tax brackets.
Money saved in a Stocks and Shares Isa is protected by the Financial Services Compensation Scheme (FSCS) up to £50,000 in the event of an investment product provider going bust. But this does not cover losses from the underlying stock market investments.
Consider the costs
Many people are attracted to investing as it offers higher returns than cash, although there is a greater level of risk attached.
You should always view your investments in the medium to long term (five to 10 years).
Remember, the value of your investments will rise and fall over time, so choose an investment strategy that’s right for you. Many people choose to drip-feed money into their Stocks and Shares Isa across the year. This means that your risk is spread over a prolonged period, rather than investing a lump sum where your cash may be vulnerable to a single stock market fall.
You can invest in a wide range of assets using a Stocks and Shares Isa including bonds, company shares and funds.
For beginner investors, Moneywise recommends using funds as these allow your risk to be spread over a greater number of holdings. If you want to invest for growth, see our feature for our top picks.
But beware of the cost of investing; each fund applies a charge to investors and you’ll also pay platform fees to the company you use to invest.
Examples of major platforms include AJ Bell Youinvest, Charles Stanley Direct, Hargreaves Lansdown and Interactive Investor (Moneywise’s parent company). Each charges a fee for using their platform to invest, this is usually a fixed fee or a percentage of your Isa’s total value. Make sure you investigate the charges and choose wisely, as picking a poor-value platform could leave you severely out of pocket in the long run.
Other ways to invest
Stocks and Shares Isas are not the only way to invest tax-free. If you’re saving for your fi rst home or towards your retirement you can also use a Lifetime Isa as a way of investing. See page 8 of this Easy Isa Guide for more information.
Another recent addition to the Isa family is the Innovative Finance Isa (IF Isa). This was launched in April 2016 and allows peer-to-peer (P2P) investments to be held within an Isa for the first time.
These accounts tend to offer much higher returns than cash savings, but the risks are much greater. Your cash is at risk if the platform if goes bust and you are not protected by the FSCS as you would be with a Cash Isa.
You should also bear in mind that peer-to-peer investment is a relatively new product and the market has yet to experience a significant financial downturn. This is likely to lead to more loans defaulting and a lower return on your investment, although some platforms do have some safeguard or provision funds in place to partially mitigate against this.
RateSetter and Zopa both offer IF Isas to customers, as do smaller players such as Crowdstacker, Crowd2Fund, and Lending Works.
Each platform has its own targeted returns, but remember that a provider will have its own way of assessing the risk posed by these loans.
Lower targeted returns do not necessarily mean one provider is safer than another, so don’t judge risk on this basis.
Finally, make sure you invest your cash across multiple peer-to-peer platforms. This means if one platform or provider goes bust, you won’t lose all your money.