It’s that time of year again, when savers are being pushed to use up the remainder of their Isa allowance. But even after 25 years, there is still confusion about how the tax-efficient saving system works.
“Isa season” traditionally runs from the start of February until the end of the tax year and encourages people to use up all their £20,000 limit before they lose it on 6 April.
But many consumers remain confused about the system, says Andrew Hagger at personal finance website MoneyComms. “There are too many Isa-labelled products with numerous rules and restrictions. It can be a minefield trying to fathom out what you can invest in, and when – it’s too much for many consumers to get their heads round,” he says.
So what do consumers need to know as the end of the tax year approaches?
How it works
An Isa (individual savings account) allows you to save money without having to pay tax on what you make on it. This could be the interest accrued, or the income from investments you make through it.
Every year there is a maximum amount you can save into an Isa – this tax year it is £20,000. There are five different types of account – cash, stocks and shares, lifetime, innovative finance, and junior.
You can split the allowance between them, apart from the junior one, for which there is a separate £9,000 allowance.
If you don’t invest by the end of the tax year, the allowance expires and a new one starts on 6 April.
There has been criticism in the past that the system is overly complicated and confusing – for example, that there are too many names for Isa products.
There have been moves to make the system simpler: next year you will be able to sign up to several Isas of the same type (such as cash) instead of just one, which is the current rule. Labour has said it will simplify Isas further if elected.
Myron Jobson, at investment platform Interactive Investor, says that “understanding the different limits, allowances and tax implications can be challenging”.
But Sarah Coles, at rival platform Hargreaves Lansdown, says that at the heart of the Isa is a straightforward tax wrapper. “Once you dip your toe in, you realise they’re far simpler than the alternative – because there’s no horrible tax-return admin to worry about.”
Cash savings
Cash Isas were once dismissed due to low interest rates. But the last 18 months have seen rates surge.
Latest figures from financial data site Moneyfacts show Virgin Money offering 5.25% for a fixed one-year cash Isa. Meanwhile, Investec Bank was offering 5.15% on a conventional one-year savings bond.
At the time of writing, the best deal on a two-year fixed-rate Isa was with Zopa at 4.7%, compared with 5.1% with iFast Global Bank for a two-year bond. UBL UK was offering 4.41% on a three-year fixed Isa, with Close Brothers Savings paying 4.6% on a three-year bond.
In the past, savers have questioned whether it is worth investing in a cash Isa following the introduction of the personal savings allowance (PSA), which means basic-rate taxpayers don’t pay tax on the first £1,000 of interest, and higher-rate taxpayers on the first £500.
But the better rates of late have meant many savers will now potentially face a tax bill for their investment, arguably making cash Isas a lot more worthwhile.
Laith Khalaf, head of investment analysis at investment firm AJ Bell, says that if he was offered the same rate on both accounts, he would opt for the cash Isa.
“PSA could be withdrawn, or cut, at some future point. Or you may simply find yourself with more cash interest, which uses up the limit.
“Now interest rates are higher, tax on savings is becoming much more of a problem, so cash Isas shouldn’t be sniffed at. The difficulty comes when you get a lower rate on a cash Isa than a savings account, which is quite common,” he says.
Stocks and shares
This year is the 25th anniversary of the introduction of the Isa. Jobson says history has shown that investing in stocks and shares is the long-term winner when it comes to returns. Cash savings are better for the short term – less than five years – he says.
Figures from Hargreaves Lansdown show that a £1,000 investment in a global tracker fund – which tracks a selection of stocks – made 25 years ago would be worth £4,094 today. The average cash Isa would have returned £1,864 over the same period, it says.
However, investors in stocks and shares Isas will have to weather the ups and downs of the stock market, which means they should be prepared for long-term investment, says Jobson.
“The key is to give your money ample time in the market to smooth out the effects of weekly market ups and downs. And don’t forget that cash rates fluctuate, too – there’s no telling if a good rate now will still be there in the future,” he adds.
Season’s greetings
The Isa season usually sees more offers come on to the market as providers try to tempt people to invest with them.
Those promoting stocks and shares Isas will often offer cashback for transferring to their platform, says Coles. “It’s never a good idea to move just for a bit of extra cash, but it’s a timely reminder to consider whether there’s a better home for your Isa money this year,” she says.
The next tax year will see further changes, in that savers will be able to partially transfer Isa funds between providers in the same year. At present, they must move the whole amount.
