From 6 April 2010, the amount that everybody is able to put aside in an ISA increases to £10,200, this is excellent news for savers which have been hard hit by recent rises in inflation and a prolonged period of low interest rates that shows no sign of changing in the short term.
How do the new limits work?
The overall maximum contribution in a single tax year is now £10,200 and the limit for cash within that goes up to £5,100.
But there is also some flexibility, you can, for example, put the maximum £5,100 in a cash account and £5,100 in a Stocks & Shares account. Alternatively, if you place £2,000 in cash for example, you can then use the entire remaining balance to invest in Stocks & Shares. If you don’t need cash at all, you can put your full allowance into Stocks & Shares.
The cost of delay, why wait to invest?
Many investors leave it until the last minute and make their annual ISA contribution at the end of the tax year meaning they lose out on tax free returns for nearly a whole year. This can be costly and mean tax is paid unnecessarily.
For example, if a couple invests £10,200 in the best non ISA Instant Access account from the Investment Sense Best Buy tables, currently the Ulster Bank paying 2.96% gross per annum and they are both basic rate tax payers they will pay tax of £60.38 in the first year and £120.77 if they are higher rate tax payers.
To put it another way, the net rate of return for a basic rate tax payer is 2.37% and 1.78% for a higher rate tax payer. When you consider inflation is currently around 3% the best available Instant Access account is actually losing money in real terms.
Alternatively the best Instant Access Cash ISA, assuming you want to invest a lump sum, is currently offered by Alliance & Leicester and pays 3.20%, a better rate of interest than the non ISA equivalent and it is paid tax free.
In a rising market the message is even more powerful when it comes to Stocks & Shares ISAs, although clearly a rising market cannot be guaranteed.
The message is clear; use your ISA allowance early in the tax year to ensure that the best possible use is made of the tax advantages that an ISA enjoys.
The myth, ISAs are no longer worth it
The view that ISAs are no longer worth it has featured in the press for several years.
It is true that the loss of the 10% tax credit on dividends for Stocks & Shares ISAs back in 2004 was a significant blow and the interest rates payable on Cash ISAs are often not as good as comparable savings accounts.
However, there are still some great reasons for ISAs to be a core part your savings and investment strategy, no matter what your age is or how much you earn.
First of all, there are the tax advantages. These are unquestionable for higher-rate taxpayers, in fact, ISAs are one of the few benefits higher-rate taxpayers still receive.
Generating a tax-efficient income, which would normally be taxed at 20%, 40% or even 50% now is particularly useful in retirement. Of course your attitude to risk needs to be considered when making an investment into anything other than a Cash ISA, however it is generally possible to find a solution to meet most people’s requirements that also benefits from the tax advantages afforded to an ISA.
ISAs can also be appealing because, unlike Unit Trusts they do not need to be declared on a tax return, especially appealing to higher rate tax payers and the self employed. Clients who have a complex income portfolio could find this particularly useful.
Although many people use ISAs to save for particular goals, Cash ISAs are also a good way to build up money for a rainy day. The economic troubles of the last few years have shown us all that redundancy is never far away when times are bad – and even people in well-paid positions are not immune to an extended period when they are not working or have to take a job on a lower salary.
In these circumstances, ISAs have another benefit – because they are not declared on a tax return, the income they pay is not counted in the calculations for Working Tax Credits or Child Tax Credits. As a result, they could help boost your income when times are tough.
A similar situation occurs in retirement. Once your taxable income is above £22,900, you lose £1 of additional age-related allowance for every £2 you earn, which is an effective tax rate of 30%. However, ISA income is not included in these calculations, so a retired person receiving income from their ISA could potentially avoid a taxable situation twice and save a significant sum.
Combining ISAs and Pensions
Of course, ISAs are just one part of effective financial planning and they are often used best when they are combined with pensions. There are many situations when a blend of pension investments and ISAs is the best option, but there is a particularly interesting one that could help people make much more of their savings.
Imagine an individual who saves £5,000 in a pension every year for two decades. They receive basic-rate tax relief for 15 years and higher-rate relief for the last five. Based on the past performance of the FTSE All-Share index, they would have a lump sum of just under £400,000 (Source: M & G).
However, if they put their money into the same funds within an ISA for the first 15 years and then moved it gradually across into the pension once they started paying higher-rate tax, their pot would be worth over £500,000, an increase of £100,000, without saving anything extra.
Once they have retired, they could then take the tax-free lump sum from their pension and drip feed it into an ISA. This could produce a tax-efficient income and they will also have the comfort of knowing it can be left to their family in their will.
If you are still not convinced, there is one final point in favour of ISAs that is much more straightforward.
There is no additional cost or penalty for holding funds inside an ISA whether it be Cash or Stocks & Shares, rather than outside, so why not take advantage of the benefits? As long as you planned to invest the money anyway, there really is nothing to lose.
At Investment Sense we have a wide range of resources available to help you make your money work as hard for you as possible.
If you are considering an Stocks & Shares ISA you can buy these direct from us and we will take no initial commission, click here for more details.