As we approach the end of the current tax year, many individuals will be considering either to invest in an Isa for the first time or to increase the levels they have invested so far in these tax-efficient products.
The decision last year by the chancellor to increase the allowance to an initial £15,000 adds to the investment attraction. The questions facing those with surplus capital is: “Do I take advantage of the allowance, and if so where do I invest?”
The attractions from a tax perspective are overwhelming. However, that on its own should never dictate the decision. Tax tails and dogs come to mind.
The lead-up to the end of the tax year will be dominated by companies highlighting the merits of their offering and advisers encouraging their clients to utilise their allowance, given it is a “use it or lose it” annual amount. It is therefore helpful at this point to ensure people fully understand what their objective is from using these products – quite simply, what are they looking to achieve and by when. No one will have the singular objective of wanting to use up the Isa allowance for the sake of it – there will always be an underlying reason that will need to be determined. While it may be an unpopular decision, for some people the correct response might be to forgo the investment and repay a proportion of their debt instead, thereby negating potential interest-rate and investment risk.
The upcoming general election – and one of the most keenly anticipated and politically divided general elections for more than 40 years at that – has created a great deal of uncertainty in the financial markets. Whoever prevails on 7 May (or later, depending upon the result) may have a radically different view towards pension and investment legislation to what we see now. One clear piece of advice is for people to retain flexibility and diversification to the various tax wrappers that they are exposed to. This allows them the ability to vary their investment and financial planning to take account of further changes to pensions, income or capital gains tax. An emergency Budget after the election is highly likely – and only then may we get a sense of the personal finance intentions of the new government.
Understanding someone’s objectives, including why they might wish to use their Isa allowance to provide them with an income, cannot be answered by a simple Q&A – it takes time to ascertain the bigger picture and to find the answers they probably do not even initially know themselves. Context to their overall financial position is required so that they can apply a true meaning to their finances. This overarching view removes the product from the equation and will lead to much more educated and informed decisions around their expenditure and risk approach. If you can achieve your objectives and what is important to you with a lower level of financial risk, why would you not do this?
Having a plan and strategy that looks at the whole financial position will lead the discussions to at least understand why any surplus income or capital requires any investment decision being made. Too often in the past individuals have made decisions from the wrong perspective and solely view it as a chance to grow their income. With this there is little to benchmark their success against anything other than a friend or an index. How do you determine risk or your tolerance to volatility if there is no overall plan – very difficult in my view, which is why we would question those who try and make huge investment decisions directly, ignoring the benefit of professional advice. Getting this wrong wipes out any tax saving and more.
Within the right context to advice, sensible discussions can take place around the options of investing or paying off any debt. No right or wrong answer here, as long as it has been considered impartially and the individual understands the suggestions made and the reasons why they are doing what they are doing are clearly evidenced. Interest rates are at historic lows, which make it attractive to retain your capital; yet at what cost will this be done should the markets fall and/or rates rise?
Assuming the decision has been agreed and that it is appropriate to invest the capital – including using Isa products – to provide a longer-term income, and taking into account the retention of emergency cash reserves, there is fortunately a plethora of choices available. Income or growth, low-risk through to speculative – there are endless decisions for an individual to make. All of this is made easier and a lot of the noise is reduced if there is a financial strategy in place. This will mean someone can clearly understand what they need to be doing and the investment risk or volatility they will need to expose themselves to if they are to achieve their objectives.
Discussing risk or volatility is an interesting subject. Is there a formulaic approach that looks to cut through the subjective nature in the eyes of the adviser, or is it as basic as being on a scale of one to 10? Either way, it will need to be justified and evidenced as to how suitable it is for an individual. We only need to reflect back to 2008 and the credit crunch to see how people reacted to risk and where we saw cautious managed funds fall on average by 20 per cent in 12 months. Try explaining that they were ‘cautious’ or for that fact ‘managed’. We do not want negativity or pessimism, but what we do have to do is have a sensible discussion around the potential downside of any investment and whether this downside can be tolerated.
Thankfully, within Isas, there is a variety of investment options catering from the lower-risk to the more speculative, and, indeed, how the monies can be managed. Selecting funds themselves and self-investing; selecting funds from an investment company and reviewing them periodically, either with or without the assistance of an adviser; moving right up to having the funds managed on a discretionary/active basis, can all be catered for. Clearly, the greater oversight and influence of the management will determine the costs involved.
The increase in the Isa allowance to £15,000 has been welcomed by investors and where possible individuals would want to utilise their allowances. However, it needs to be set against a financial plan. The ideal scenario for individuals is that they are accumulating funds in a variety of tax wrappers so that they can take advantage of their allowances to give them the most advantageous and flexible income/capital in the future.
Bryan Innes is executive partner at Towry
Key Points
The tax position of Isas should never dictate the decision to invest in the vehicle.
Understanding someone’s objectives takes time to ascertain the bigger picture
Risk and volatility will need to be justified and evidenced as to how suitable an Isa is for an individual
