Back in 1999, then Chancellor Gordon Brown announced the introduction of the ISA. While they have since become an integral way to save, they were not welcomed when first introduced. In fact, Labour MP Quentin Davies branded them a “colossal failure” just months after they launched. Despite the negative outlook for ISAs initially, they did eventually become an important part of many peoples’ financial strategy; £870 billion has been placed in ISAs in the last two decades.
The key benefit of saving in an ISA has remained the same throughout the last 20 years; the gains you make from interest or investment returns are tax-free. This incentive reflected the tax-efficient alternatives that the ISA replaced. The now defunct Personal Equity Plans (PEPs) are broadly similar to a Stocks and Shares ISA, while a Cash ISA is comparable to the obsolete Tax-Exempt Special Savings Accounts (TESSAs).
When they launched, the ISA allowance was split between investing and cash. For the tax year 1999/00 the allowance was £7,000 for a Stocks and Shares ISA and £3,000 for a cash account. Splitting the subscription limit between the two types of ISA changed in July 2014, allowing you to distribute your money across ISAs in a way that suits you. The current annual subscription limit is £20,000, where it has been since 2017/18.
An essential way to save
From pessimistic beginnings, the ISA has become a critical way to save. Whether you are just starting to save or are building up an investment portfolio for retirement, ISAs probably play an important role in your overall financial plan. Official statistics for 2017/18 prove that it has become one of the most popular financial tools:
- Around 10.8 million Adult ISAs were subscribed to
- Around £69 billion was subscribed to Adult ISAs; an increase of £7.8 billion compared to a year earlier
- The average subscription was £6,409; an increase of 15% on 2016/17
- The market value of ISA holdings stood at £608 billion
Cash or Stocks and Shares?
When deciding how to use your ISA allowance, one of the key questions to consider is the type of account to place it in; cash or stocks and shares. They both have pros and cons to weigh up, and which is right for you will depend on your financial situation. Cash ISA subscriptions tend to be more popular, they made up 72% of all ISA subscriptions in 2017. However, this does not necessarily mean it is right for you.
Cash ISAs: With a Cash ISA, you earn interest on your deposits. The money placed in a cash account is safe, it will not fluctuate, and, assuming you stay within the limit of the Financial Services Compensation Scheme (FSCS), up to £85,000 will be protected per person per authorised bank or building society should an authorised financial services firm fail.
While your money is protected within a cash account, there is one thing to keep in mind; inflation. With interest rates still low following the financial crisis, the impact of inflation means your savings are likely losing value. As the cost of living rises, your savings will have diminished spending power over time, effectively losing your money in real terms.
Stocks and Shares ISAs: In contrast, a Stocks and Shares ISA could help your money keep pace, and hopefully exceed, inflation. As your money is invested, it has the opportunity to deliver returns that maintain or increase your spending power.
Of course, the key consideration with a Stocks and Shares ISA is the risk. As your money is invested, it will be exposed to market volatility. This means the value of your investments could decrease. Typically, with a Stocks and Shares ISA, you will be able to select from several risk profiles, allowing you to choose the one that most closely matches your attitude to risk.
When choosing between a Cash ISA and a Stocks and Shares ISA, it is important to look at what your goals are and the timeframe. A Cash ISA can be a useful place to store a financial buffer that you may need to dip into or for saving objectives that are short term. Conversely, it is usually advisable that you invest with a minimum timeframe of five years in mind. As a result, a Stocks and Shares ISA may be better suited to long-term goals.
It is important to remember you do not need to choose between the two main ISAs when deciding where to place your money. You can potentially spread your £20,000 annual subscription limit across different types of ISAs, building a mix of saving and investment accounts if you choose.
The evolution of ISAs
As the importance of ISAs has risen in financial planning, new ISA products have launched, offering incentives and more ways to save.
Junior ISA: A Junior ISA is a tax-efficient way to save for children. An account can be opened for children under the age of 18. The annual subscription limit for a Junior ISA is currently £4,260. Like their adult counterparts, you can choose from a Cash Junior ISA and Stocks and Shares Junior ISA. The child can take control of the account once they reach the age of 16, for example, choosing the underlying investments. However, no withdrawals can be made until they are 18, at which point it will be converted into an Adult ISA.
Lifetime ISA: The Lifetime ISA (LISA) is designed to act as an incentive to save for a first home or retirement. Again, a Lifetime ISA can hold either cash or be invested. The incentive here is that the government offers a 25% bonus on deposits, boosting savings. A maximum of £4,000 can be deposited in a LISA each tax year. You can only open an ISA if you are between 18 and 40, although deposits can be made until you reach 50. The drawback with a Lifetime ISA is that withdrawals can only be made penalty-free to act as a deposit for your first home or after the age of 60.
Help to Buy ISA: The Help to Buy ISA aims to support those buying their first house. It can be opened with an initial deposit of up to £1,200. From here you can save up to £200 each month. When buying their first home, savers can apply for a government bonus of either 25% of deposits or £3,000, whichever is higher. Any UK first time buyer over the age of 16 can open a Help to Buy ISA. To qualify for the government bonus, you must be purchasing your first home to live in, be using a mortgage, and the purchase price of the house can be a maximum of £250,000 (£450,000 in London).
Innovative Finance ISA: The Innovative Finance ISA first became available in 2016/17. It is designed to act as a vehicle for peer-to-peer lending. Returns are potentially higher when using peer-to-peer lending, however, the level of risk is also higher. As a result, they may not be a suitable option for you. The annual subscription limit for an Innovative Finance ISA is included in the £20,000 limit across all ISAs.
If you would like to discuss which ISA product is right for you, please contact us. We will help you identify which ISA is right for your wider goals and financial plan.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.