ISAsMar 27 2019

How Isas have fared over the past 20 years

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How Isas have fared over the past 20 years

The products are now a firm favourite as a tax wrapper, with around £69bn subscribed to more than 10.8m adult Isas in 2017-18. However, as different types of Isas have been introduced, the rules have become increasingly complex. (See Box 1). 

When Isas were first introduced, the limit was £7,000. The Isa limit for 2019-20 is remaining at £20,000, where it has been since April 2017. Adults can subscribe up to £20,000 within the tax year into any combination of the wrappers, provided they only hold one of each type. For this purpose, the H2B Isa is classified as a Cash Isa. 

The Lisa limit is remaining at £4,000, with Lisa subscriptions counting against the overall £20,000 limit. The 25 per cent government bonus is paid on top.

The ‘one-Isa-of-each-type’ rule means that when a current-year Isa is transferred to a new manager, the current-year subscriptions are treated as if they were made to the recipient Isa. 

Subscriptions must be made by cash. The one exception is where shares were issued under a Schedule 3 save-as-you-earn option scheme, or a Schedule 2 share incentive plan, provided the shares are transferred into the Isa within 90 days of the date the investor exercised the options. 

If an individual had invested the full Isa allowance from 1999 onwards, they would have made total subscriptions of £206,560. If they had invested the full allowance at the start of each tax year and achieved 5 per cent annual growth their Isa pot would be worth just under £324,000. In comparison, had they used their allowance at the very end of each tax year, then their Isa would be worth £308,500. 

Flexible Isas

Flexible Isas were introduced in the 2016-17 tax year. They are not a separate type of Isa, but a feature available on existing products, although most Flexible Isas tend to be Cash Isas. 

Any withdrawals from a Flexible Isa can be replaced in the same tax year without using up more allowance. This facility can be useful for short-term cash flow, but relies on the withdrawn sum becoming available again within the same tax year. The danger is that the individual sees the Isa as more of a current account; discipline can be required to ensure that the money is returned to the Isa wrapper. 

First-time buyers

There are two Isas available to help first-time buyers save for their property purchase: Help to Buy Isas and the Lifetime Isa. It is not possible to use both the H2B and Lisa for a property purchase, so the would-be buyer should assess which product is most suitable for their circumstances. 

A H2B Isa can be opened with an initial deposit of up to £1,200, after which contributions are limited to £200 per month. If a contribution is not made one month, it cannot be added on to a later month. 

A 25 per cent bonus on the total account balance – the amount of contributions plus interest accrued – is added at the point of completion of the house purchase, with a maximum £3,000 bonus. The home must be a first property purchase and valued at £250,000 or lower – the limit is £450,000 for London property purchases. 

The H2B Isa will close to new savers on December 1 2019, although subscriptions can be added to existing accounts until November 30 2029. The bonus needs to be claimed by December 1 2030, meaning that house purchases where the bonus is to be used must be completed by this date.

The savings limit for a Lisa is £4,000 per tax year, with the government adding a 25 per cent bonus to the contributions each year. This means that the individual can invest the bonus and benefit from any growth on it. 

The Lisa can be used for a first house purchase up to the value of £450,000 once it has been opened for 12 months. The Lisa must be opened before the investor’s 40th birthday and subscriptions can continue up until their 50th birthday (see Box 2). 

Inheritability

Isas became inheritable following an announcement in the 2014 Budget. The inherited Isa value is known as the additional permitted subscription and is available to surviving spouses/civil partners where the Isa holder died on or after December 3 2014 and who were not separated at the date of death. Where an investor held Isas with several companies, a separate APS will be available for each.

The APS rules vary depending on date of death. If the Isa holder died before April 6 2018 the APS is equal to the value of the Isa on the date of death. The Isa wrapper fell away on date of death, meaning that any income or gains from that point are taxable on the estate. 

If the Isa holder died on or after April 6 2018, their Isa becomes a ‘continuing Isa’. The Isa wrapper remains in force until the earliest of:

  • The completion of the administration of the estate;
  • The third anniversary of the date of death;
  • The closure of the Isa due to all the funds being withdrawn.

Here, the APS is equal to the higher of the value of the Isa on the date of the investor’s death or the value of the Isa on the date it stops being a ‘continuing Isa’. This means that any income or gains arising from the date of death, to the point the Isa ceases to be a continuing Isa, are not taxable on the estate. 

Tax planning

Isas can provide a core part of financial planning, particularly since the introduction of the pension freedoms. For example, the products can be used to supplement income in retirement. This reduces the income tax liability compared with taking pensions income, and also preserves the inheritance tax-favourable pension fund. 

Despite not being taxable, Isa income can be gifted under the normal expenditure out of income exemption. This immediately removes the income from the estate for IHT purposes, meaning the IHT liability is not increasing. 

Isas can also be a good home for an emergency fund or care fees planning, as large, ad hoc sums can be withdrawn without triggering any income tax or capital gains tax liability.

Victoria Harman is senior technical expert at Hargreaves Lansdown