15 Apr 2024
As we say goodbye to the old tax year, and hello to the new, investors and savers will most likely be considering how to make the most of their tax-free allowances. Outside of pensions, the standard UK tax-free wrapper is of course the much-loved ISA (Individual Savings Account) which was launched in 1999 and turned 25 this month.
What’s the vibe with ISAs? British savers are moving more money into tax-free accounts than ever before, with the cash ISA currently the number one choice. Almost £50 billion more was put into cash ISAs in 2023 than was taken out, and it looks like that direction of travel will only intensify in 2024. According to the Bank of England, across January and February 2024, savers deposited a whopping £6.1billion, up from a net £3.8 billion last year. Cash ISAs are the most popular by a country mile; in 2021 to 2022, 11.7 million ISAs were opened and 7.1 million were cash accounts.
What are the different ISA options? In 1999, at the outset, there were two types of ISA - cash, and stocks and shares. There are now 5 options (lifetime, Junior, Innovative Finance, stocks and shares, and cash) and if you count the help to buy ISA, which you can still hold but no longer open, and the soon to be released British ISA, there are 7 to choose from.
So, what’s making cash ISAs so popular to investors? Returns on cash were close to zero for years but there’s been a monumental shift with savings rates rising sharply over the last two years. You’re now looking at interest rates of around 5% and with inflation falling, savers can earn a positive real return on their savings. Outside of an ISA, basic rate taxpayers can earn up to £1,000 a year in interest free tax. For higher rate payers this falls to £500, so with rates at around 5%, the attraction is obvious.
With record sums being committed to cash ISAs in recent months, should stock market investment be put on the back burner? Let’s look at the backdrop; savings rates are not expected to stay as high as they are currently and interest rates might not be falling as fast as many had hoped but, barring any big inflationary shocks, they’re on a downward trajectory. Cash ISAs are clearly the most popular option but if you want your money to work harder and are happy to take some risk, investing over the longer term might create a more flourishing pot.
What are the scenarios? If you had used your full ISA allowance each year since the accounts were introduced, you would have saved £306,560. According to Vanguard, putting your money into cash savings over the same period would have given you a return of £355,592 but let’s imagine you’d opted for a global stocks index fund – your pot would now be worth £727, 357.
If you’re looking at investments outside of a tax-free wrapper, you will need to consider the changes to the tax regimes over the last two years. In April 2023, the capital gains tax (CGT) annual exempt amount was reduced from £12,300 to £6,000 and from 6th April 2024 it was reduced further to £3,000! The dividend allowance has also been sliced in half from £1000 to £500 for the tax year 2024/25, having been cut from £2,000 to £1,000 in the year 2023/24. Big changes in a short space of time and it only takes some relatively modest increases in the value of an investment portfolio before investors start to incur tax liabilities on their investments.
Which ISA is likely to deliver the best returns over the long-term? Cash ISAs are straight-forward and appealing and come with some certainty but if you can bear the volatility associated with investments in securities then a stocks and shares ISA could be the way forward. Your savings have the potential to rise significantly over time with this option and the longer you invest, the more likely you are to ride out the peaks and troughs along the way.
All client’s circumstances are different, so holding some level of cash for short-term needs and emergency expenses is a sensible strategy. For the average investor though, holding large amounts of cash over the longer term doesn’t make sense and inflation will inevitably lead to an erosion of their real wealth over time. Investing comes with greater risk but a well-rounded portfolio can bear rich fruit in the long run. As rates fall and returns fall off, the opportunity to maximise returns over the medium to long term with a diversified portfolio is undeniable.
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This information is for UK Professional Advisers only and should not be given to retail clients.The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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