An ISA (Individual Savings Account) is designed to be a simple and tax efficient way to save money. But with very low available rates, combined with the changes to the personal savings allowance, many have questioned whether any kind of ISA is still a good deal. So, what are your options if you’re looking to save in the most efficient way possible – and does an ISA still feature in them?
Why ISAs are a good idea
ISAs have evolved over the past couple of years and now offer a very wide range of choice for tax free savings. Today, you have the option of tax free savings or a tax free investment account that you can open via a broad selection of different building societies, banks, asset managers or insurers. The ISA seems like a great idea – a way to accumulate cash without attracting tax up to an annual limit (in the 2017-18 tax year, you can put £20,000 into a cash ISA). However, these savings vehicles do have issues. The main problem is that ISA rates are currently very low (1.1% per annum), which means that there isn’t going to be much of a return on the cash that is invested into the ISA.
The personal savings allowance
Another key reason for the current lack of interest in ISAs is a change in the law that introduced a new personal savings allowance on 6 April 2016. As a result of this allowance, a basic rate taxpayer can now earn interest of up to £1,000 on savings not in an ISA and this interest is tax free. For higher rate taxpayers this drops to £500. Many believed that the introduction of the personal savings allowance meant the end of the line for the ISA, given that the tax free savings offered by both are currently almost identical. However, there are a few differences to bear in mind:
ISAs can be passed on tax free on death, which doesn’t apply to other savings products
If you move into the higher rate tax band then your allowance for the personal savings allowance drops by half
ISA products continue to diversify and offer a wide range of ways to invest as well as save
ISAs today – what are your options?
There are a growing number of ISAs to choose from and some of the less traditional are offering considerably more impressive rates of interest than the standard 1% on a cash ISA.
The Innovative Finance ISA. If you’re looking to get the highest return from an ISA then the Innovative Finance ISA has the most impressive rates. This is a new type of ISA that is based on the idea of peer-to-peer lending. So, you – together with other investors – are effectively lending your money to individuals or businesses and the returns that you make on these are tax-free. Currently, there are Innovative Finance ISAs that are offering targeted returns of around 7%, some of which can be opened with just £1. It’s important to bear in mind that this is a different type of product to other ISAs because of the investment angle involved. The returns are not guaranteed and you could lose your money if there is a complication, for example the business that your money has been loaned to goes bust. These ISAs are also generally not protected by the Financial Services Compensation Scheme.
The Stocks and Shares ISA. When you put your money into this type of ISA it is invested into stocks and shares, such as government bonds or individual company shares. Any income and gains that you make as a result of the investment are tax free (these would normally be taxable). So, the Stocks and Shares ISA offers a way to increase your savings, up to the limit, without paying tax. And you’re not limited to interest rates – returns depend instead on the performance of the stocks and shares you put your money into. Bear in mind that there are a number of charges that apply to this type of ISA and your investments can go down, as well as up.
The Lifetime ISA. This type of ISA has a specific purpose: saving for a home or saving for retirement. As long as it is used for this purpose then savers get a bonus additional 25% on top of whatever goes into the account. The Lifetime ISA has an annual limit of £4,000 a year and you need to be under the age of 40 to open a Lifetime ISA. If you don’t use the cash you’ve saved for the specific purpose then you will lose that extra 25%.
Alex Hartley is a keen advocate of improving personal finance skills. She's worked at Solution Loans since 2014 and written hundreds of articles about how people can manage their money better. Her interest in personal finance goes way back to...Read more about Alex Hartley