The start of March signals the beginning of the so-called ‘ISA season’, when savers and investors pour billions of pounds into cash and stocks-and-shares ISAs.
The annual ISA allowance is going up again; anyone aged 16 and over can now shelter up to £20,000 from tax in an ISA in 2017/18, compared to £15,240 in the 2016/17 tax year. You must be over age 18 to invest in a stocks-and-shares ISA or an innovative finance ISA (A new type of ISA launched last year, offering access to peer-to-peer lending).
For cash savers, interest rates are still very low. Even if you lock your money away for two or three years in a fixed-rate cash ISA, the rates are still only 1-1.25%.
If you are prepared to take a bit more risk, then a stocks-and-shares ISA is an option. These ISAs, which are usually invested in the stock market (see January newsletter) or bonds (see February newsletter), can potentially deliver much better returns than cash over the long-term. This of course, is not guaranteed, because no one knows how the stock or bond markets might perform in the future so you may not get back the amount that you paid in.
Junior ISA limits are also set to rise from £4,080 this tax year to £4,128 on 6 April 2017. Junior ISAs have limited use, as children can of course make use of their own personal tax allowance – currently £11,000 a year rising to £11,500 from 6 April. If all their income, including interest from cash deposits and dividends from shareholdings falls within their personal allowance, they won’t pay any income tax. The November 2016 issue of Thinking Ahead covers investing for children in more detail.
So when might it be a good idea to consider ISAs? If you’ve used up your pension allowances, or need access to the funds before age 55, ISAs are worth thinking about as a means to shelter investments from taxation.
Now it’s time to meet LISA
Another new type of ISA is also set to launch on 6 April 2017 – the Lifetime Individual Savings Account, or ‘LISA’ for short.
The LISA will be available to people aged 18 to 40, so if you don’t open one before your 40th birthday (or you were 40 on or before 5 April 2017), you can’t take out a LISA.
Savers can put away £4,000 a year into a LISA and will receive a 25% bonus – up to £1,000 a year – on top of their own savings.
You should be aware that any money paid into a LISA also counts towards your normal ISA allowance, so if you pay in the maximum of £4,000, you’ll only be able to pay in £16,000 to your other ISAs.
The LISA can be used tax efficiently to purchase a first home or for retirement from age 60 onwards. However, don’t opt out of a workplace pension scheme to invest in a LISA, as you will lose your employer’s pension contribution.
If you do open a LISA, you can continue to receive the 25% bonus on new contributions right up until your 50th birthday.
When a normal ISA could make more sense
If you take money out of your LISA other than for the purchase of a first home or for retirement, you will suffer a 25% penalty of the total amount. Because of the way the maths works, you will get back less than you put in, even though the 25% penalty is the same percentage as the bonus. It works like this – you put in say £4,000 and get a £1,000 (25% of £4,000) top-up giving you a total of £5,000. If you take the £5,000 back out to pay for a holiday you will suffer a £1,250 penalty (25% of £5,000) leaving you with just £3,750.
If you do intend to take money out other than for purchase of a first home or retirement, consider a normal ISA instead.
For retirement, LISAs are slightly more tax-advantaged than a normal pension, but only for basic and nil-rate taxpayers. However, unlike a workplace pension, you aren’t entitled to an employer contribution into a LISA. And, for higher rate taxpayers who pay basic rate tax in retirement, a normal pension is more tax-efficient.
All of this means that LISAs are probably best used for saving up for a first home. If you take money out for this reason, and the value of the house is less than £450,000, you won’t suffer a penalty.
The first available LISAs are more likely to be cash LISAs. Most of the big financial services providers are unlikely to launch stocks-and-shares LISAs by April, so you might get a better choice by waiting a few months.
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