Friday HighlightMar 23 2018

Five ways to make your Isa work for you

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Five ways to make your Isa work for you

As the end of the tax year looms, thoughts have turned to Isas and how to make the most of the allowance. 

1. No Isa at all?

The Cash Isa was shunned by some savers last year, with money subscribed during the 2016-17 tax year dropping drastically by some £19.5bn from the previous 12 months, according to HMRC .

The same figures suggest that some of this Cash Isa money may have been ploughed into Stocks and Shares Isas (a rise of £1.2bn inflow over the same period), but just where has the other £18.3bn gone? 

The tax-free Personal Savings Allowance could be one of the key drivers. The option to keep either £1,000 interest (for basic rate tax payers) or £500 interest (for higher rate) sheltered from tax outside an Isa wrapper provides much greater flexibility for cash savers to shop around for the most competitive interest rates available.

Some recent research has shown that many advisers believe their clients hold too much money in their Cash Isa relative to the rest of their portfolio.

So far, so good.

But while the flexibility afforded by the Personal Savings Allowance may be much needed as interest rates remain stubbornly low, many people who choose to take this route may end up paying tax on their savings further down the line as the amount of their savings will increase as and when interest rates do rise.

From this perspective, a Cash Isa may still prove a suitable option longer-term as the money inside the wrapper is protected from tax for life.

2. Is the Cash Isa working?

Some recent research has shown that many advisers believe their clients hold too much money in their Cash Isa relative to the rest of their portfolio.

Where a client has both savings and investments, it may make more sense to house cash savings outside an Isa and instead use the wrapper to protect the higher potential returns available through either a Stocks and Shares Isa, or the Innovative Finance Isa (IFISA).

This in no way suggests that people should move their cash savings altogether but it could be worth thinking about whether a Cash Isa wrapper is the best way to use the tax-free allowance.

If more people adopt this approach and continue to be drawn by the Personal Savings Allowance, then it may not be unrealistic to say that this Isa season could mark the beginning of the end for the Cash Isa.

Before going down this route, potential investors must know they can keep cash savings elsewhere, and also be aware of the additional risks involved.

3. From Cash Isa to Stocks and Shares

The recent inflows into Stocks and Shares Isas could suggest some people are opting to shift Cash Isa savings into investment markets to try to access inflation-beating returns.

Stocks and Shares Isas offer a large amount of investment choice, which can bring with it the benefit of diversification.

However, investing in the stockmarket puts capital at risk, exposes one to volatility and the value of a portfolio can go down or up – based on factors beyond an investor’s control.

Whether this is the right option for someone will depend very much on how much risk they can afford – and want – to take on.  

4. Consider the Innovative Finance Isa as a ‘half-way’ approach?

The Innovative Finance Isa has been around since April 2016 but initial uptick was slower than expected as many major crowdfunding and P2P platforms awaited FCA authorisation.

However, the vast majority of these platforms have now officially launched their IFISAs and, for the Isa savers that are out there seeking an alternative home for some of their money, it could certainly be worth a look.

On the one hand an IFISA does not provide the same level of security or liquidity offered by a Cash Isa – capital is at risk and there is no FSCS deposit protection – but potential returns are significantly higher. For example, Downing Crowd Bonds have a weighted average interest rate of 5.9 per cent per annum, across the first 22 bonds as at 7 February 2018.

So using the tax wrapper to protect a potential 5.9 per cent, rather than 1 per cent, might make sense.

These investments will be uncorrelated to investment markets but as there is no guarantee of liquidity, the IFISA may be best suited for money that you are happy to have tied up.

From this perspective, the IFISA could serve as a ‘half-way’ between the two more established Isa wrappers for those prepared to take on the risk.

5. Could a blend of Isas offer the best of both worlds?

For intermediaries looking to increase the diversification of clients’ Isa portfolios away from low interest rates and volatile markets, investors don’t need to have all their eggs in one basket.

Every year they have the option to open one Cash, one Stocks and Shares and one Innovative Finance Isa.

Or, if they have been sticking with one type of Isa for the past few years, they can use all of their £20,000 allowance in 2017-18 to do something different.

Julia Groves is partner and head of crowdfunding at Downing LLP