- Shrinking allowances make Isas key to financial planning
- The UK Isa is not the only change coming up
- Which funds and stocks would have made you an Isa millionaire?
Planning our financial life is hardly ever as clear-cut as we would like it to be. In an ideal world, we would know ahead of time how much money we will need, when and what for. But in real life, the car breaks down, children's school fees increase, inflation has made retirement more expensive, the stock market has been volatile and taxes are going up.
Against this uncertain backdrop, individual savings accounts (Isas) combine flexibility with tax advantages. You don’t need to know in advance exactly what the money is for or when you will need it in order to make the most of your £20,000 annual Isa allowance. In many cases, you can take the money out at any time and access it without having to worry about a potential tax bill. And if you opt for a flexible Isa, you can take money out and put it back in without it impacting your overall annual allowance.
There are complications to bear in mind, and it is in this context that calls for the simplification of the Isa regime abounded once again in the run-up to the Spring Budget earlier this month. But if it is true that the number of different Isas on offer could be slimmed down to better serve the needs of savers and investors, the wide range of options available do provide plenty of choice. From a standard stocks-and-shares Isa for your regular investments to a Junior Isa for your kids’ school fees, to a cash Isa for your rainy-day fund, the tax wrapper can meet a variety of goals.
There may soon be one more to add to the list. The Budget brought the biggest Isa news in a long time, in the form of a consultation regarding an extra £5,000 allowance dedicated to domestic stocks. As well as supporting UK companies, the British Isa will be an additional opportunity for savers to grow their money tax-free.
Whichever option or options you choose, sheltering your investments from taxes becomes more important every year as the tax burden increases. Having already been reduced last year, the capital gains tax (CGT) allowance and the dividend tax allowance will fall again this April, with the former dropping from £6,000 to £3,000 and the second from £1,000 to £500. That means any investment held outside a tax wrapper will start accruing a tax liability much more quickly. At the same time, income tax thresholds are due to remain frozen until 2027-28, with more people dragged into the higher and additional rate bands as a result. That means paying considerably more tax on both dividends (a rate of 33 per cent or more) and capital gains on your investments (rates in excess of 20 per cent).
“No one wants to pay tax on money they have already been taxed on,” says Alice Haine, personal finance analyst at Bestinvest. “And this is a ‘use it or lose it’ allowance because you cannot carry it into the next tax year if it isn’t used. Savers looking to secure this year’s £20,000 allowance in full before it disappears must fund an account with that amount by 5 April.”
Isa changes
Will the British Isa go ahead? With an election arriving later this year, and a consultation to work through, there is some uncertainty. The details also still need to be worked out: the consultation suggests that qualifying assets could include shares listed on UK stock exchanges, including Aim, as well as corporate bonds and gilts, and funds and investment trusts – potentially only those that have at least 75 per cent of their portfolios in eligible UK companies. There would be restrictions on holding cash or cash-like assets in the account.
The new Isa will only truly make a difference for investors who typically exhaust their regular allowance every year. But it is welcome news for them, considering that the regular allowance has lost some of its value in recent years. Set at £20,000 since the 2017-18 financial year, it would be worth in the region of £25,000 in today’s money.
By definition, those who utilise both the UK Isa and the standard Isa allowance in full would need to allocate at least 20 per cent of their new Isa investments to UK assets every year – a significant but not unpalatable home bias, considering that the UK made up 3.7 per cent of the MSCI World index as of 29 February. Laith Khalaf, head of investment analysis at AJ Bell, says that a good starting point to build an actively managed global portfolio is to allocate 20 per cent each to the UK, US, Europe, Japan and emerging markets.
Meanwhile, a much smaller set of changes to Isas, announced by chancellor Jeremy Hunt in the Autumn Statement last November, will take effect from this April. Savers will be able to subscribe to multiple Isas of the same type every year and to partially transfer Isa funds between different providers. At the moment, you can put your allowance towards Isas of different types, but you cannot pay into two different Isas of the same type. For example, you can put £10,000 in a stocks-and-shares Isa and £10,000 in a cash Isa, but not £10,000 into two cash Isas.
The changes should come in handy for investors who want to use different platforms for different investing styles. For example, you might want to have a stocks-and-shares Isa for holding open-ended funds for the long term, and another one for individual shares and trading. Equally, it could be useful to have both a fixed-rate cash Isa for money you don’t need immediately and an easy-access cash Isa for your rainy-day fund.
You can already make transfers between providers without impacting your Isa allowance. For now, you can move as much of your Isa from previous tax years as you like, but if you want to transfer money put into your Isa in the current tax year, you must transfer all of it. From April, partial transfers during the tax year will also become possible, giving you even more flexibility.
However, recent rumours of a reform of Lifetime Isas (Lisas) did not materialise at the Budget. Taking money out of a Lisa (other than for buying your first home or once you turn 60) continues to attract a penalty of 25 per cent of the amount withdrawn – higher than the bonus you get from the government when you pay into the account. And the maximum value of a property that first-time buyers can use a Lisa to purchase remains £450,000. Campaigners have long pushed for a change to these features, on the grounds that house prices have increased significantly since the limit was set and that people saving or investing money in Lisas should not be punished if their plans then change.
Time in the market
If you near the end of the tax year without having allocated your Isa allowance, you might find the idea of investing £20,000 in one go intimidating. But while you do need to add the sum to your account by 5 April, you don’t have to invest it instantly. If you are unsure how to distribute the assets, or worried about market movements, you can do it more gradually over a few weeks, for example holding the rest in cash within a stocks-and-shares Isa.
But keep in mind that 'time in the market' remains one of the key principles of long-term investing. Interest rate cuts remain a possibility later this year, and while there are still plenty of risks, the power of compounding means missing out on big market moves to stay in cash can cost you dearly over the long term. And as Khalaf points out: “Lump sum Isa investing is actually regular by nature, if you do it every year, and hence smooths out your entry price into the market. You will buy at both peaks and troughs, and everywhere in between, so trying to fathom whether the market is good value is an occult art which Isa investors don’t need to dabble in if they stick to their savings plan.”
As of April 2021, the UK had more than 4,000 Isa millionaires: people who have grown their Isa portfolios to seven figures and above. Given the total maximum annual contribution possible since Isas were introduced in 1999 has historically been far lower than £20,000, most of the heavy lifting was done by investment growth. The table below shows the top 10 funds, investment trusts and UK stocks that would have made you an Isa millionaire by investing the full Isa allowance right at the start of each tax year since Isas were introduced in 1999.
If you have considerable assets in your general investment account and not a lot of new money to put to work for the tax year, it is worth considering a so-called bed & Isa transaction. This entails selling the assets you hold outside the wrapper and buying them back into the Isa, in order to shelter them from a future tax bill. If you want to make use of the CGT and dividend allowances before they are cut again, this is a good solution, and good platforms should offer a service that does this for you automatically.
But keep in mind that by doing so you are still realising your existing gains, which will result in a CGT bill if you are above the allowance for the year. Depending on your platform, there could also be some transaction costs, and the price of the securities may change due to the time lag between selling them in your general account and buying back in your Isa.
Still, with the CGT and dividend allowances being slashed first in April 2023 and then again next month, bed & Isa transactions are proving popular. Interactive Investor says requests on its platform increased by 53 per cent in 2023 compared with 2022.
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