A diatribe about ISAs

This Loose Change article is by Faith Archer, an award-winning personal finance journalist who is also a money blogger at Much More With Less about moving to the country, living on less and making the most of it.

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Why oh why did the government have to take a good thing, and make it complicated?

I’m talking about Individual Savings Accounts (ISAs).

The beauty of an ISA is that any money you put into one is protected from the tax man. You are allowed to set aside a certain amount of money each year, and keep the proceeds without paying an extra penny in tax.

The ISA is just a bag to protect your money. You choose what to put into the bag. Whether you want to stay in cash, or branch out into investing, you keep all the interest, dividends and growth earned on money inside your Isa. Unlike a pension, you can get hold of the money whenever you want. You don’t even have to mention Isas, or any money taken from them, on your tax return.

ISAs should be so simple: a reward for saving, when most of us don’t save anywhere near enough. Use an ISA, and keep more of your money. The end. Now they are a maze of different options and limits.

Messing around with tax allowances

Trouble is, successive chancellors couldn’t leave well alone.

Now there’s a proliferation of ISAs, not just cash ISAs and investment ISAs.

With a cash ISA, you can salt away a chunky £20,000 a year and earn tax-free interest from the age of 16. With an investment ISA, you can also salt away £20,000 every tax year – but only after you reach 18. There used to be limits on how much you could put in cash, and how much in investments, but all that got swept away, which I applaud. The limit is £20,000 a year, chuck it around as you wish.

But I don’t think politicians really like cash ISAs, because they introduced a Personal Savings Allowance, which means you can earn up to £1,000 a year in interest tax-free (if you’re a basic rate taxpayer) and even £500 a year in tax-free interest as a higher-rate taxpayer. So you don’t really need to use a cash ISA to earn tax-free interest any more, unless you really intend to keep a ton of money in cash.

Plus there’s now a Dividend Allowance, to earn £5,000 a year in dividends on investments outside an ISA without paying tax. Only that allowance is being cut back to £2,000 from April 2018, so maybe investment ISAs aren’t such a bad idea after all, especially as Isas also protect your money from Capital Gains Tax.

Starting with a Junior ISA

Meanwhile different ISAs have popped up all over the place.

Varieties depending on age, depending on type of investment, depending on what you’re saving for, all with different rules and regulations.

Step forward the Junior ISA, for children under 18 – which could be in cash or investments. Started off as a Child Trust Fund, but that involved giving people £250 vouchers when their child was born, which got ditched when the saving for children was hitched to the Isa bandwagon.

However, the Junior ISA limit isn’t the £20,000 a year limit for an ordinary ISA, but only £4,128 a year, rising to £4,260 after the beginning of the next tax year, on April 6. Plus remember that 16 or 17 year olds can also open their own cash ISA at the same time.

Trialling a Help to Buy ISA

Then the powers-that-be decided to meddle in the housing market using ISAs.

The Help to Buy Isa was launched at the end of 2015, to help first time buyers over the age of 16 (not 18) save for a deposit. Put money in a Help to Buy Isa, and the government will add an extra 25%. Many cheers!

But watch out for the small print:

• You can’t put in £20,000 like ordinary ISAs. Instead, you can only save up to £200 a month. But oops, you can actually open an account with £1,200 not just £200. My bad.
• You can only stick the money in cash, not investments. Although this isn’t a bad idea when saving for a deposit.
• The top up doesn’t start immediately. No, you have to save £1,600 before you get any extra money.
• Oh and the maximum bonus is limited to £3,000.
• You can’t use it on all properties. Just less expensive ones, so homes worth under £250,000. Or under £450,000, but only in London.
• Plus you can’t actually use your Help to Buy ISA bonus as an initial deposit on the property, because the bonus is only paid out via your solicitor when completing on your purchase.

Blink and you’ll miss them, because new Help to Buy ISAs will only be available until 30 November 2019.

Adding a Lifetime ISA

Not content with the Help to Buy ISA, the government launched a Lifetime ISA last year, from April 2017. This one also helps first-time buyers – but only those under the age of 40, and over 18 (rather than 16).

The Lifetime ISA also gives you an extra 25%. Cheers again!

Weirdly, a Lifetime ISA can be used for either a deposit on your first home (so long as it’s bought for less than £450,000, dropping the Help to Buy Isa £250,000 limit outside London, and provided you wait at least a year after opening the account before buying) or for retirement.

I say weirdly because I would normally save for a deposit in a few years’ time using cash, whereas I would stick long-term retirement savings straight into investments. Because oh yes with a Lifetime ISA you can save in cash OR investments, unlike the cash-only Help to Buy ISA.

Now with a Lifetime ISA you can save larger amounts than with a Help to Buy ISA – up to £4,000 a year, rather than capped at £200 a month with a maximum £1,200 opening deposit. But still not the full £20,000 ordinary ISA limit, although you can pay into an ordinary cash or investment ISA at the same time as a Lifetime ISA. And you can only contribute up to the age of 50, whereas with an ordinary ISA you can keep contributing until you pop your clogs.

Also with a Lifetime ISA, you get paid the 25% bonus sooner. After April 2018, the Lifetime ISA bonus will be paid every month. This is great, because it means you can earn extra interest and growth from the bonus.

However, it also means the government slaps on a penalty if you withdraw money that isn’t for the desired aims. Withdraw money without using it to buy your first property (under £450,000) or before the age of 60 (which doesn’t match the age to get hold of other retirement savings like pensions) and the Government lops 25% off the top. Due to maths, that means they claw back more than the initial 25% bonus they gave you. (Trust me, it really does).

So if you are under 40, and saving for your first home, a Lifetime ISA is actually a good way to grab some free money. But if you’re saving for retirement, it gets a thumbs down if you’re employed (as you miss out on employer contributions to a workplace pension) or if you’re a higher or additional rate taxpayer (as you’d miss out on extra tax relief from pension contributions) or are planning to leave your pension fund to your children and have a ton of other assets (because pension money doesn’t count as part of your estate when calculating 40% inheritance tax over the inheritance tax threshold, but ISAs do).

But at least with a Lifetime ISA any money you take out after the age of 60 is completely tax-free, unlike money from a pension, where only the first 25% is tax-free. So there’s that.

Oh and an Innovative Finance ISA

And if you haven’t already switched off completely, there’s also an “Innovative Finance” ISA, introduced from April 2016. It means you can include peer to peer lending within an ISA. Why give it a new name? Why not just say: you have £20,000 a year, you can split it between cash, investments and peer to peer lending any way you want?

Losing the will to live

If you’ve read this far – congratulations.

With each extra complication, I can feel the will to live slipping away.

The more people have to weigh up their options, the fewer people actually get round to opening ISAs. Each additional rule, limit and complication is like a paper cut, building up to a whole world of pain. We should be encouraging people to save, rather than making the decision more difficult.

Saving for children is a great plan – but you might want to use some of your own ISA allowance, so your little darlings can’t blow everything in a Junior ISA when they reach 18 and get their hands on the lot.

Saving for a deposit is a great plan – so if you’re a first-time buyer under 40 and aiming to buy a property worth less than £450,000 in more than a year’s time (and breathe), grab the free money from a Lifetime ISA.

And if you start investing – opening an investment ISA, rather than investing outside an ISA, really is a great plan. If you take away one message from this diatribe about complicated ISAs – use an investment ISA when investing.

(Unless you use a pension. Which is a whole other world of pain when it comes to regulations and complications.)

Faith Archer