We run through the Isa options most likely to suit the requirements of different age groups.
Individual Savings Accounts (Isas) are a useful way to stash up to £20,000 each tax year in a wrapper the taxman can’t touch. They remain popular with savers, who poured a record £608 billion into adult Isas in 2017/18. But the focus is shifting. With interest rates on cash Isas pitifully low and the personal savings allowance exempting most people from paying tax on their savings, cash Isas’ popularity has waned, while inflows into stocks and shares Isas have hit new highs.
Moreover, with a handful of other types of Isa now on the market, could savers be missing out by not considering alternatives, especially given recent stockmarket volatility? Here are some suggestions for the best Isas to see you through every life stage.
A Junior Isa (Jisa) is an obvious choice for under-18s: parents or guardians can open an Isa for their child and save up to £4,260 a year into it tax-free. The child can take control of the Junior Isa at 16 and it becomes their money to withdraw or add to at 18.
Jisas can be either in cash (you don’t pay tax on the interest earned) or stocks and shares (you don’t pay tax on any capital growth or dividends received), or both. Financial advisers suggest that, with a time horizon of up to 18 years, it makes more sense to invest in the stockmarket.
Steve Danson, chartered financial planner at Banks Wealth, says: “If you are thinking of starting a Junior Isa for a baby, that is a long investment term to be in cash.” He suggests putting the money into a global managed fund instead; he favours something like Fidelity WealthBuilder for a diversified range of equities. “You can always lower the risk as you move towards the point at which your child gets control,” he adds.
The underlying investments you pick will depend on your attitude to risk, says Hayley North, chartered financial planner at Rose & North. “What would be in a Jisa depends on the parents’ choices – they might want an ethical portfolio, they might want something higher-risk if they have that in their own portfolios, or they might want it to look like cash if they are scared of investing in equities. If you are not comfortable taking investment risk for yourself, don’t take it for your kids either.” But for those who do want to invest, she suggests a medium-risk portfolio from a well-known brand should work for most people.
If you would rather save in cash, first check if you can get a better rate on a traditional savings account, as basic rate taxpayers don’t pay tax on the first £1,000 of interest their savings earn. Young savers can open their own adult cash Isa from the age of 16.
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Young adults 18-30
A big financial goal for this age group is home ownership. There are two Isas designed to help with this – the Help to Buy Isa and the Lifetime Isa. The first gives a 25% government bonus on your savings of £200 a month, up to a total bonus of £3,000 on £12,000 saved. But if you want one you’ll need to be quick, as they are only available until 30 November 2019. If you’ve already got one you can keep paying in, but you will need to claim your bonus by 1 December 2030. Bear in mind you can’t pay into a cash Isa and a Help to Buy Isa in the same tax year.
Replacing the Help to Buy Isa is the dual purpose Lifetime Isa (Lisa), the newest Isa on the market. Some 166,000 people opened one in the product’s first year. It lets you save towards your first home and/or retirement, with a 25% government bonus on savings of up to £4,000 a year. The maximum total bonus you could get from it is £32,000, so it’s not to be sniffed at. You can open one between the ages of 18 and 39, keep contributing until age 50, and withdraw from it either to buy your first home or from the age of 60.
You can hold a Lisa and a Help to Buy Isa, but you can only use the bonus from one towards your house purchase. Should you choose a cash or stocks and shares version? Lowland Financial’s managing director Graeme Mitchell says: “If it is for a house deposit when you are younger, you don’t want to run the risk of it dropping 10% before you need it, so probably it’s best to keep it in cash.”
Finally, in this age group you might want a stocks and shares Isa for general savings and long-term stockmarket exposure, especially if you’re not likely to need to access that money for a few years.
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Family life 30-50
Launched in 2016, the Innovative Finance Isa (IFisa) lets savers use some or all of their annual Isa allowance to lend funds through the peer-to-peer lending market. The major players in this space, such as Zopa, RateSetter and Funding Circle, all offer IFisas, and the potential returns are much higher than you’d get on cash deposits (although returns are not guaranteed).
But investing this way is not without risk. If you’re in your 30s, you’ve bought a house, have a cash emergency fund and a pension and you’ve still got spare money, an IFisa could be a fun way to put it to work. “The Innovative Finance Isa is a nice-to-have rather than a core element, as it is riskier,” says North. “It might work in mid-life, not close to retirement or at 16, but in the middle chunk of life when you can take a bit more risk.”
In this age group you could also still have your stocks and shares Isa for general savings, and your Lisa for retirement, as you can pay into it and get the bonus up until the age of 50. However, advisers say a Lisa should not replace a pension for most people.
What investments should you hold in them? Mitchell says if you are looking for the absolute lowest cost, tracker funds are a good addition, although more expensive active funds tend to have the edge in volatile times. He suggests risk-graded portfolios from Vanguard that are available to DIY investors through most major investment platforms. “The younger you are, the better you are in low-cost solutions such as tracker funds,” says Mitchell. “Put it away and almost forget about it. If you are worried about volatility, stop looking at your statements.”
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Towards retirement 50-60
If you’re getting closer to retirement, you should have a decent emergency fund and money for your short-term cash needs, but putting it in a cash Isa may not be the best option. “Yes, you should use your Isa allowance each year but, if you are saving for the longer term, stocks and shares Isas could do better than cash if you are prepared to take some risk. You could have £20,000 in a cash Isa or in a cash bank account like Santander 123,” says Danson.
“Even outside an Isa you don’t pay tax on the first £1,000 of interest earned, so it seems like a wasted opportunity to put your money into a cash Isa unless rates go up, in which case you’d be happy to have squirreled some money away in a tax wrapper.”
Moneyfacts has calculated that if interest rates were to hit 4%, non-Isa balances of £25,000 and over would become taxable for basic-rate taxpayers, or £12,500 and over for higher-rate taxpayers.
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Golden years 60+
Isas still have a role to play once you’re in retirement. Conventional wisdom would suggest a cash Isa is best, on the grounds that older people will be focused on capital preservation, but in fact you may want to take on more risk with a stocks and shares Isa.
Mitchell notes that many retirees will take advantage of the 25% tax-free lump sum they can withdraw under pension freedom rules, which would cut their overall risk. “It doesn’t necessarily follow that people will want to reduce risk in retirement,” he argues. “Tax-free cash brings your risk down so you could take more risk in a stocks and shares Isa.”
A cash Isa, however, could offer a useful way to take tax-free income in retirement, given your other pension income will be taxable, says North. “If you’ve got a surplus of funds at retirement, Isas are useful; we’ve got a lot of elderly clients who still use them. Saving £20,000 doesn’t sound like a lot, but it builds up quickly and you can end up with a sizeable pot. They can be really beneficial when people are looking for extra income. Cash Isas and stocks and shares Isas can also be useful for higher-rate taxpayers who have exhausted what they can put into a pension and still stay within their annual allowance.”
In addition, she continues, there is the inheritance element: “Married partners can inherit each other’s Isas [tax-free] if one dies.”
At the age of 60 you can also start withdrawing from your Lisa penalty-free, boosting your retirement income. Although Danson is not a fan of the Lisa for retirement and would always suggest pensions instead, he says other types of Isa have a place in retirement planning. “They are great as part of an overall retirement strategy – if you’ve got money in Isas and other accounts and investments, you can regulate the income tap from the various sources to get the amount of money you need in retirement, while paying the least amount of tax.”
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This article was originally published in our sister magazine Money Observer, which ceased publication in August 2020.
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