Despite the long-term benefits on offer, many savers will still fail to make the most of this year’s ISA allowance.
Although the Chancellor left the annual ISA allowance unchanged in his Autumn Statement instead of applying an inflation-linked increase, the opportunity to shelter up to £15,240 with no further tax to pay on income, and growth free from Capital Gains Tax, is still a very attractive and valuable one. What also hasn’t changed is that your allowance will be lost forever unless you invest before the end of the tax year.
Yet the majority of ISA savers still fail to make the most of the opportunity.
A recent survey conducted by BlackRock explored the savings views and habits of 4,000 individuals in the UK. While it revealed an encouraging increase in the number of people saving for retirement, it also confirmed that Britain’s cash-centric savings culture remains a problem. Around two thirds of all personal savings and investments are stuck in cash, compared to an average of 12% invested in equities; and this is despite those surveyed acknowledging that the figure is too high¹.
The trend is equally concerning when it comes to how people are utilising their ISA allowance. Figures from HMRC show that over £79 billion was saved into ISAs in the last tax year, of which a staggering 80% was deposited in Cash ISAs². This figure was backed up by BlackRock’s research, in which 70% of respondents said they held a Cash ISA, whereas just 11% had invested in a Stocks & Shares ISA.
Consequently, over £240 billion is languishing in Cash ISAs on which, according to the Bank of England, savers are receiving an average interest rate of just 0.85% – lower than the 0.99% reported in December³. Many banks are now paying higher rates of interest on current accounts than savings accounts⁴.
Based on the average figure, savers depositing their full allowance in a Cash ISA would save themselves tax of just £26 on the interest if they were a basic rate taxpayer; and £52 if they paid tax at the higher rate.
The introduction of the Personal Savings Allowance from April makes the real value of such tax savings even more questionable. The new allowance applies to standard current and savings accounts and will enable basic rate taxpayers to earn tax-free interest of up to £1,000. For higher rate taxpayers the tax-free limit is £500, whilst those with total income of over £150,000 a year will not get an allowance.
If you can deposit cash in an instant access account earning tax-free interest, why would you need a Cash ISA? In theory, you might if you would exceed the tax-free limit in earned interest.
The average instant access rate is currently 0.48%³: at that level, a basic rate taxpayer could deposit over £208,000 in a regular savings account and receive all their interest tax-free. For higher rate taxpayers the figure is just over £104,000. Of course, for those who secure a more attractive rate, these amounts would be reduced.
The primary role of cash is as a home for emergency funds. It seems unlikely that many people would need a larger emergency pot than they can now save tax-free in an instant access account.
BlackRock’s survey also offered an insight into why the cash saving habit is proving hard to kick. Participants said they feel “responsible” and “purposeful” when they opt for cash saving, but “anxious” and “cautious” when they invest in other assets, such as stocks and shares. But faced with the prospect of record-low returns on cash, and little likelihood of a significant rise in interest rates, some might question whether this confidence is justified if the money saved in ISAs is intended to help secure their financial future.
BlackRock’s research reaffirmed that ISAs have a major role to play in encouraging retirement savings. Over half of those aged 55–64 said they were using ISAs to help fund their retirement; and across all age groups, 36% are saving with that objective in mind.
Pension changes due to be introduced in April will see a reduction in the annual allowance for higher earners, and a lower lifetime allowance for pension savings. It is therefore anticipated that the flexibility offered by ISAs will see them used even more widely as part of a well-structured retirement planning strategy.
The long-term benefits of ISAs were further enhanced by changes introduced last year, which enable spouses to inherit an additional ISA allowance equal to the value of their deceased partner’s ISAs, so preserving the tax benefits that would previously have been lost.
The reality is that the tax benefits of an ISA can only be maximised by investing for the long term in assets that offer the scope for attractive levels of income and capital growth.
There is still time for those looking to take advantage of the tax-saving and investment opportunities presented by the end of the tax year. Making the best use of your ISA allowance before it’s too late would be a good start.
The value of an ISA with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than invested. An investment in a Stocks and Shares ISA will not provide the same security of capital associated with a Cash ISA. The favourable tax treatment of ISAs may not be maintained in the future and is subject to changes in legislation.
¹ BlackRock Investor Pulse Survey, December 2015
² HMRC, August 2015
³ Bank of England, January 2016
⁴ BBC website, January 2016