With £62.8 billion subscribed to ISAs in the 2016-17 tax year alone, it’s pretty clear that us Brits like our tax-free savings. However, as the investment climate has changed dramatically over the last decade or so, so too has our attitude to the popular tax wrapper.
According to HMRC, the amount invested in ISAs in the 2016/17 tax year fell by £17 billion compared to the year before. The majority of this came from Cash ISAs, which saw their share of the amount subscribed to ISAs drop from 80% to just 60% of the whole market.
Rising inflation and poor interest rates are clearly starting to take their toll on British savers’ passion for the ISA. However, with a raft of new ISA types now coming on to the market – such as the Innovative Finance ISA or Help to Buy ISA – could it be time to take another look?
The problem is, there’s quite a lot of them. It can make it hard to work out which one is right for you.
So, here’s our overview of some of the benefits and drawbacks of the various types of ISAs currently available. As you’ll see, it’s important to understand that different ISAs have different risks – and you should think carefully about what’s appropriate given your own investment objectives and risk appetite.
Remember also that the specifics of each ISA product – such as rate, term and charges – will vary depending upon the provider. Note, too, that tax treatment depends on individual circumstances and is subject to change.
Where else to start? The bread & butter of the ISA world, Cash ISAs work like your normal bank savings account, except any interest you earn is tax-free.
The rate of interest tends to rise and fall in line with the Base Rate, set by the Bank of England. Currently, the best rate you can get on an instant access ISA is 1.6%.* You could get up to 1.81% if you lock your money away for a two-year fixed term, but you’d struggle to beat inflation (2.3% at the time of writing) – meaning that your money’s actually losing value in real terms while sitting at the bank.
Despite the low returns, though, Cash ISA investments carry no investment risk. Being saved in a standard bank account, they are covered by the Financial Services Compensation Scheme (FSCS) – meaning all your savings will be guaranteed, providing the amount you have saved with that financial institutional doesn’t exceed £85,000.
- No investment risk – savings are guaranteed by the FSCS
- Stable return
- Low rate of return compared to other ISAs; currently below inflation.
Stocks & Shares ISA
A stocks & shares ISA gives individuals the opportunity to take more risk, in exchange for a potentially greater return. Rather than saving your money at the bank, these ISAs involve investing in stocks, bonds or mixed funds, in the hope that the value will increase.
Over the long-term, investors will often expect to receive attractive returns – often in the region of 8-10%. However, it’s not always an easy ride. The volatility of the stock market means that the value of your investment tends to fluctuate over the short-term, which can be unnerving, to say the least.
As a result, stocks & shares ISA investments tend to be long-term in nature, and often aren’t considered appropriate for those that may need access to their funds in the near future. And, as with any investment, you should remember that your capital is at risk, and you may get back less than you put in.
This is where it’s important that you’re clear about how much risk you’re willing to take as an investor.
- Potential for high rates of return
- Your money will be put at risk
- Can be very volatile
- Unlikely to be instant access.
Still relatively new to the game, the IFISA has given investors a way to target an inflation-beating return, without putting their money in the stock market. Instead, their money can be invested in peer-to-peer (P2P) loans.
The nature of these loans can vary wildly, and will depend on the product and provider. Some will invest your money in unsecured business or personal loans that hope to achieve rates as high as 8-12%, however a great deal more risk will come with that. If the borrower fails to repay their loan, there’s no security that can be used to help fund the debt.
On the other hand, there are secured P2P lending products – like Octopus Choice – which invest your money in property-backed loans. This helps mitigate the risk to investors, as, should a borrower fail to repay their loan, the property can be sold to fund the debt.
These types of investments can be much less volatile than stocks & shares, too. Your returns rely on the borrowers paying back their interest, meaning the value of your investment isn’t tied directly to the value of the asset.
You should note, though, that P2P investments are not covered by the FSCS. Also, while some products don’t have a fixed term, instant access to your money cannot be guaranteed.
- Potential for high rates of return.
- Much less volatile than stocks & shares
- Not covered by the FSCS
- Your money will be put at risk
- Can’t be guaranteed instant access
A Lifetime ISA (sometimes called a ‘Lisa’) is designed to support individuals saving for retirement or purchasing their first property. Alongside being tax-free, the government will also pay you a bonus of 25% on the amount you save each year. However, this only applies if you withdraw the money to purchase your first home, or once you reach the age of 60.
You’re limited to putting in a maximum of £4,000 a year, and can only do so between the ages of 18 and 50. Those making a withdrawal before they are 60 – or using their withdrawal to fund anything other than a property purchase – will lose their bonus and may be penalised.
Lisas are available either as a Cash or Stocks & Shares offering, meaning there are options for people with different risk/return appetites.
Much like a Lifetime ISA, a Help-To-Buy (HTB) ISA is geared around supporting people saving for a house deposit. The differences being that:
- You can open one from the age of 16.
- There are only cash options available.
- You’re restricted to depositing only £1,200 in the first month, then a maximum of £200 a month after that.
It’s also worth noting that you can transfer your Help-To-Buy ISA into a Lifetime ISA.
Junior ISAs (JISAs) are intended to encourage parents to save for their child’s future. The money invested in a JISA will then be transferred to an adult ISA (in the child’s name) when they turn 18.
There’s a maximum annual investment of £4,128, with the option of both Cash JISAs or Stocks & Shares JISAs.
So, which one’s for me?
Choosing the right ISA really all comes down to each investor’s specific circumstances, and how much risk you’re prepared to take with your money. And of course you don’t have to commit yourself to just one type of ISA. Instead – so long as the total amount invested doesn’t exceed your annual ISA allowance (£20,000 for the 2018/19 tax year) – you can build a diversified portfolio of tax-free investments. You can even transfer existing ISA investments into other ISAs, without affecting your annual allowance.
For those with limited funds available, and who might need to rely on the money at some point to support themselves, instant access Cash ISAs might be more sensible. Besides, you’re automatically entitled to earn £1,000 interest tax-free under the Personal Savings Allowance.
However, if you have a bit more flexibility, it’s worth thinking about what level of risk/return you’re prepared for, and whether an ISA with higher target returns could work best for you. And we recommend speaking to a financial adviser, too, who will be best placed to help you make these decisions.
Either way, ISAs offer a brilliant opportunity for savers and investors to earn interest tax-free, and try to achieve their financial goals.
Don’t forget, investment ISAs place your capital at risk, and it is possible you’ll get back less than you put in. Also, tax treatment depends on individual circumstances, and could be subject to change.
*Based on the average savings rate available from HSBC, Barclays, Santander, RBS and Lloyds on instant access ISAs, with a balance of£20,000 (Aug 2018)