Everything You Need To Know About ISAs

Everything You Need To Know About ISAs

 

The big draw of individual savings accounts, or ISAs, is that they are exempt from income and capital gains tax.

First introduced to the UK public in 1999 to encourage long-term saving and supplement individuals’ pension plans, ISAs were brought in to replace the more complex Personal Equity Plans and Tax-Exempt Special Savings Accounts.

At first, there were only three broad types of ISAs: cash, stocks and shares, and life insurance. There was little interest in the separate life insurance ISA and it was subsequently withdrawn from the market in April 2005.

Currently, the cap on investment or savings through ISAs in a single financial year (April 6 to April 5) is £20,000 in total. This amount can be split amongst the various types of ISAs, just as long as it doesn’t exceed the £20,000 allowance[1].

ISAs can currently be divided into four broad classes: cash (basic), stocks and shares, lifetime, and innovative finance ISAs (IFISAs):

 

Cash ISAs

These are aimed at conservative investors and savers with a low appetite for risk. The concept is pretty straightforward. They earn a small amount of interest tax-free and are provided with stable returns – which often struggle to beat inflation.

 

Stocks and shares ISAs

These can potentially provide decent returns, but there's more risk involved due to the volatile nature of stock markets. These types of schemes are more suited to long-term investors with a healthy risk appetite.

 

The lifetime ISA

Launched in 2017, this allows those between the age of 18 and 40 to save up to £4,000 per year[1], which counts towards the annual £20,000 ISA allowance. The government then tops up the savings or invested amount by 25% per financial year until the saver reach the age of 50. These were designed to supplement retirement income in the long term, and for first-time buyers to use as a deposit on a property in the short term.

 

Innovative finance ISAs

These were introduced in April 2016 and offer an alternative to investing in the stock market. They allow individuals to invest via companies that offer peer-to-peer (P2P) lending on a variety of investments, including personal and small business loans as well as loans to property developers, without the involvement of a bank or building society. While this is probably the riskiest approach, it also has the potential to deliver the highest return on investment.

 

Other ISAs

There are two more ISAs, which are aimed at specific investors:

 

The Help To Buy ISA

This will no longer be available after November this year but they were introduced in December 2015 as an incentive from the government for first-time house buyers. Under this scheme, which is restricted to cash, the government will supplement people’s savings by 25% (up to a maximum of £3,000) when they purchase a property of up to £250,000 in value (£450,000 in London).[2]

 

Junior ISAs

These were designed for parents to build up savings for their children; up to £4,260 a year can currently be invested on their behalf into cash or stocks and shares ISAs, or split between both until such a time as they reach 18, when they can switch to an adult ISA.

 

Investor appetite

According to the most recent government statistics on ISAs, the number of people subscribing to adult ISA accounts dropped from 11.1 million in 2016-2017 to 10.8 million in 2017-2018. [3]

Much of this was due to people opting out of cash ISAs – the number of people subscribing to them was down from the previous year by 697,000 in 2017-2018. Moreover, as a percentage total of ISA subscriptions, cash ISAs accounted for 72% of the total in 2017-2018, having plummeted from 77% in 2016-2017 (2018).

However, the number of people subscribing to stocks and shares ISAs increased by 246,000 in 2017-2018 (2018), which demonstrates that large numbers are becoming increasingly dissatisfied with cash schemes.

People are now prepared to take on more risk and are increasingly turning to cash alternatives such as stocks and shares ISAs and innovative finance ISAs in order to maximise returns on their savings and investments.

 

Investing in property

Within the stocks and shares ISA segment are schemes that focus solely on property investment. There are currently property investment firms offering the opportunity for investors to combine their savings and collectively invest them in residential property funds such as real estate investment trusts (REITs) via the ISA arrangement.

These funds then use the money invested to buy properties for let in select locations; the rental income and equity gains are subsequently shared amongst the pool of investors. And, as with any ISA, income and capital gains are tax-free for up to £20,000 invested in any single tax year.

This approach can potentially deliver very lucrative returns, but with that comes a much higher level of risk.

 

Property innovative finance ISAs

Through innovative finance ISAs, investors now have the potential to fund property developments via P2P platforms.

As the loans they make through their innovative finance ISA holdings by means of the P2P are backed up with bricks and mortar, it gives the investors the reassurance of having a stake in a hard asset. This means that if the borrower were to default on the loan in any way, then it [the investment] could be used as collateral to uphold their investment.

As such, investing through an innovative finance ISA offers some advantage over stocks and shares ISAs, as their investment is uncorrelated to traditional listed equity and bond markets. And with cash ISAs struggling amidst the current high inflation, low-interest rate environment, innovative finance ISAs provide investors with a tempting alternative that can potentially bring them substantial returns, albeit with a greater degree of risk.

The ISA market continues to provide more effective ways of saving and investing than any traditional savings account ever could. While it is likely that innovative finance ISAs will continue on their upward trajectory thanks to ambitious investors, there will always be a place for cash and conservative savers.

 

 

[1] 2018. Gov.uk, Individual Savings Accounts (ISAs), Gov.uk, 2018.

[2] 2018. HM Treasury, Help to Buy: ISA Scheme Quarterly Statistics, 30 November 2018.

[3] 2018. HM Treasury, Help to Buy: ISA Scheme Quarterly Statistics, 30 November 2018.

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