ISAs – 20 years on
This is the year ISAs turned 20 and statistics suggest it has become a huge hit with savers. The value of adult ISAs stand at over £600 billion, shared between around 22 million account holders.
They have also proved popular with successive Chancellors as a means of encouraging the saving habit with the annual subscription limit having almost trebled since launch.
Their relative simplicity has undoubtedly played a key part in this success, but they’re more than just a tax free piggy bank.
ISAs have evolved over the last 20 years to play an important role in shaping and influencing how clients organise their wealth to achieve their life goals.
One of the main attractions of an ISA is that savings can be accessed at any time, whether invested in cash or stocks and shares. This removes any emotional barrier to not being able to access your own money when you want to and that makes them ideal for building up a ‘rainy day’ fund, or targeting for a specific event at a future date.
The introduction of schemes such as Help to Buy and Lifetime ISA (LISA) have added a little more complexity but with some added incentives for first time house buyers provided they meet certain conditions. The LISA also provides the same incentives for retirement provided clients don’t access the money before age 60.
More recent innovations include:
- ‘Flexible’ ISAs – ISAs where the provider will allow funds to be withdrawn and replaced within the same tax year without affecting the annual subscription limit. This can be particularly useful for those who need money in an emergency. But before withdrawing funds always check that the ISA manager offers this flexibility. Not all providers offer it and once withdrawn it cannot be repaid to a different ISA.
- Additional permitted subscriptions (APS) – widowed clients can now claim a one-off subscription limit equal to the value of their deceased partners ISA at date of death. This can be significant in protecting assets from income and gains. ISA savers in the 65 and over group account for the highest average savings value of over £42k, and it’s not uncommon to hear of accounts in excess of £100k. For deaths after 5 April 2018 the value will not only cover the value at date of death, but in most cases the income and capital gains made during the administration period of the estate.
The ‘tax free’ status of ISA investments is the main draw. There’s no tax on income or gains during roll-up or at the point of withdrawal. This can boost savings, but will also reduce tax administration as self-assessment is not required.
The tax free treatment of income and gains can free up allowances and lower rate tax bands for other assets outside the ISA, such as buy to lets, dividends from owner managed businesses and other investments.
In addition, the income generated from ISAs doesn’t count towards any of the income definitions that determine the personal allowance, pensions tapered annual allowance or child benefit tax charge.
ISAs may also help clients who wish to take gains out of a portfolio within their annual capital gains tax allowance. If they want to buy back the same shares or OEICs, they would normally have to wait 30 days because of the ‘share matching rules’. But such shares can be bought back through an ISA immediately, so that clients are not out of the market for a month. This transaction is sometimes referred to as ‘bed and ISA’.
IHT and retirement planning
ISAs can dovetail neatly with other forms of tax and retirement planning to create a better outcome for clients.
As a client gets older and their need for an ’emergency’ fund diminishes, they may be looking to retirement needs and leaving a tax efficient legacy for their family.
If they’re close to, or at retirement it may make sense to consider maximising pension funding from their ISA savings if they don’t have other resources. There are several reasons for this:
- Pensions offer the most attractive tax incentives for most people. Tax relief at highest marginal rates on the way in, and the availability of 25% tax free cash on the way out will prove a better deal than ISA for most people seeking a retirement income, even if they pay the same rate of tax in retirement as when they were working.
- Pensions can be accessed at any time after age 55.
- Pensions are protected from inheritance tax. ISAs will normally form part of the holder’s taxable estate and potentially liable to IHT at 40%. There could, of course, be a tax charge on pensions when a beneficiary draws money from an inherited pension pot, but only if the member died after the age of 75. Even then the tax charge will be at the beneficiary’s own tax rate which may be less than 40% and delayed until it is actually taken. But there may be an opportunity to manage affairs to ensure it’s taken in a year when other income is low.
The pension option will, of course, depend on clients having enough pensionable earnings and annual allowance, and an eye must also be kept on where funds stand in relation to the pension lifetime allowance.
Funding a pension using ISA funds won’t always be possible, either because a client has no pensionable earnings or has perhaps triggered the £4k money purchase annual allowance. But ISA funds may still have a part to play in effective retirement planning. Retirement income needs could be better served from the ISA rather than pension, again for IHT reasons – better to use a pot that is subject to IHT than one that isn’t.
Clients can, however, engage in IHT planning with their ISA even if they don’t wish to, or are not able to recycle into pensions:
- Any income produced in the ISA and taken by the client can be included in valuing income in relation to the ‘normal expenditure out of income’ exemption. If this income adds to, or creates ‘surplus’ income, it can be given away and will be immediately outside the client’s estate.
- Those able to take on greater risk could turn to an ISA that facilitates investment in shares on the alternative share market (AIM shares). Once held for two years, and provided the shares remain qualifying, they won’t get caught in the IHT net.
A client’s plans on how they intend to use their ISA savings will of course influence how it’s invested. If ready cash is needed, or funds are earmarked for a specific date (particularly if that date is short term), they’re not likely to take on much risk. Funds may therefore sit in deposit or fixed interest funds.
But if a client has both ISA savings and non-ISA savings, given the historically low interest rates and the availability of the personal savings allowance (PSA), it may be advantageous to keep their ISA invested predominantly in stocks and shares with their ready cash held outside their ISA. This is because stocks and shares are more likely to provide a higher return than interest, and so the ISA wrapper will give greater protection from tax, particularly if there would be no tax on interest anyway. And stocks and shares can now easily be moved into cash within an ISA if a client’s attitude to risk changes.
Similarly, if a client wishes to use their ISA to hold stocks and shares but there are bear market conditions at the time they wish to make their subscription, they could always make pay into a cash ISA. This means their subscription is not wasted, and will be ready to move into stocks and shares when market conditions are more favourable.
And of course, why wait until the tax year end to take advantage of the annual subscription. Probably down to human nature, but many will leave it until the tax year end before paying in and will have missed out on nearly a whole year of tax free income and growth.
ISAs have evolved over the last 20 years into a flexible savings plan that’s central to the holistic financial planning for a client. Much more than just a rainy day savings plan.
Source and Credits – Standard Life Technical -30 April 2019
As Independent Financial Advisers we can help and advise you on the tips listed above. Just give us a call on 0345 013 6525 to discuss.