Thanks to the recent Budget, more young workers will be shielded from having to pay tax on their earnings. It’s a good reminder of why a tax-free Isa, not a pension, should the first port of call for any young saver. Read on to find out why many industry experts want these tax-free accounts to become the backbone of our savings strategy in the years to come.
by Iona bain
Roll up roll up! The new tax year is about to begin. Every bank worth its salt is setting out to persuade customers to use their tax-free savings allowance from the 6th April.
But why would you listen to them? Well, if you’re not already using an ISA, you are really missing a trick.
Recently, I set out my case for a new approach to long-term saving among young people. That is because the repeated cries for pensions are misguided.
For instance, here is the stern admonishment of the chief executive of Friends Life, Andy Briggs, who is basically in the business of selling us a pension. It came on the back of research last year from the Future Foundation, which said we need a new age of personal responsibility because young people are spending too much at the moment to save for their future. He says:
It’s no surprise that for younger generations the idea of instant gratification prevails. But the common argument of ‘I can’t afford to save’ wears slightly thin when you compare regular savings habits with regular outgoings such as gym membership or satellite TV. The widely held belief that the future will take care of itself is a misconception we cannot ignore. I think individuals should shoulder part of the blame. Yes, we all have many choices facing us in life but what we need is a new age of personal responsibility rather than just relying on the government and our employers.
It is ironic that this generation have often been accused, in a rather extreme way, of refusing to give up jam today to have jam tomorrow.
Arguably, it is the older generations, not today’s current crop of young workers, who have been most at ease with borrowing to attain a lifestyle beyond their means. If some young people have been persuaded this is a good idea (and many are far too canny to believe that), it is only because they have been influenced over a long period of time by a society that has promoted and depended on unlimited credit.
It is unfair for pension providers to characterise us as reckless and dooming ourselves to an impoverished retirement. Young people are saddled with an array of financial problems, now paying for that societal addiction to debt. It will mean that we will have to work longer for a smaller pension. How fair is that?
And is it unreasonable to for young workers to be cynical when it comes to pensions? Not when Merryn Somerset Webb, editor of MoneyWeek, says we should abolish the pension system altogether. Writing in last month’s FT Money, she said:
Pensions are complicated. Pensions are confusing. Pensions are expensive to administer – for both state and saver. For all these reasons, they are a licence to print money for too many product providers. Worst of all, they aren’t even much good to most people. Let’s not forget that pensions are not “tax-free”. Instead, all they do is defer the tax you pay on your cash.
She makes an alternative proposal:
Increase the annual Isa limit to somewhere around £30,000, with some kind of lifetime contribution limit included too. Make a big deal about how money comes out entirely tax-free. Not having to pay tax on my income when I am old is an attractive option to me and I bet I am not alone.
Here is what Ros Altmann, the country’s unofficial spokesperson for pensions and pensioners, has to say about this:
The ‘pensions or nothing’ policy is going to leave too many with nothing! Workplace ISAs, pensions and debt repayment accounts can really help revitalise savings in a way that pensions alone will not. Government wants to help workers get used to the benefits of saving, but forcing them into a savings account that will deny them any access to their own money for decades will mean many opt out, for understandable reasons. If they were saving in a ‘Lifetime Savings’ vehicle, which could be used if needed for other saving requirements, this would be far more likely to encourage them to save, as well as helping their lives.
Until more is done to make pensions appealing and effective, our generation will be perennially put off the idea of saving into an invisible pot of money that they can only access when they retire.
But, of course, if we don’t educate young people on the overall value of saving, we will find many on the cusp of impoverishment, tempted to borrow and being forever taken for a ride by financial institutions, not only in their retirement but every year up to that point.
We’ve just got to be given the push towards this option, either by our parents, our school teachers or by the media. But that would be so much easier than forcing us prematurely towards pensions.
So let’s get back to basics. What if more young savers knew that they can deposit £5,640 into a savings account, every year, without having to pay any tax? Okay, many of them may not be earning enough (or anything) to be in the position of owing HMRC a pound of two. If that is the case, saving might seem like a luxury too far.
But there is still something to be said for putting any spare cash you have, however small, into a regular savings account. Conventional wisdom dictates that this could cover any emergencies where you’ll need access to a few hundred pounds at short notice. Say you or one of your flatmates has a ghastly ‘accident’ (I’ll let your wild imagination fill in the details) and your landlord says you’ll have to cough up the money to rectify the damage. Unless you can make a quick trip to the bank of Mum and Dad (and many of us would find the shutters down if we tried), you’ll be glad to have some savings to tide you over.
It is surprising how quickly money accumulates in a savings account (especially if you pick one that pays a healthy rate of interest). If you’re not paying any tax, you’re in the enviable position of getting a headline rate. There’s quite a few accounts that are easy to access online, don’t require you to deposit a set amount every month, and will pay a very decent interest for your efforts.
Fortunately, the recent Budget will also allow many of us to earn a little bit more without having to pay tax. I calculated that I’ll be about £200 better off a year thanks to this tweak of the rules.
Gideon’s good news for young workers only serves as a timely reminder to get saving in an Isa, simply because when the axe of tax falls, it can be brutal for those on a small budget.
Bear in mind that you can’t replace any of the money you have taken out of an Isa during the tax year. So if you put the maximum £5,640 in and take out £200 that year, you won’t be able to put that back in again for the tax year. Another way to explain it is this. Say you put £2,000 in on 6th April and take out £1,000 for a gap yah to Thailand, that amount can never be replaced within the overall limit. So if you get a windfall from generous granny who forgives your endeavours abroad and can put in an excellent £2,000, you’ll get your Isa total up to £3,000 – but you’ve only got £1460 to go, because that £1000 has been taken off the table and can never be put back in – doh!
But very few young savers will be able to put the maximum amount in anyway. If you fall in that category, you should really opt for an easy access Isa – that way, you can use it to access money if you need it, so long as this doesn’t happen on a regular basis.
At the moment, it’s up to young savers to uphold their end of the bargain and resist dipping into their savings all the time. That’s supposedly what makes pensions a more rigorous option – no danger of anybody tapping into their savings too soon, allowing the pot of money to grow over a working lifetime and yield a substantial annuity upon retirement. If only that was a cast-iron guarantee. The experience of many disappointed retirees says otherwise.
Isas are a terrific starting point and all savvy savers should get their skates on to find the best deal out there. As the allowance creeps up by £600 this year, Isas are going to be having what fashionistas call “a big moment”, not least because so many experts are calling for them to become our main form of long-term saving in the future.
MY ISA MANIFESTO
1) An Isa is not the be-all and end-all, but it’s a fantastic way to kick-start your saving habit.
Find an easy-access Isa paying a decent rate of over 3%, one that doesn’t require an onerous, minimum deposit.
2) A penny saved is a penny earned.
It is the only way to build up enough funds for a deposit on a house, a new car or some other essentials.
3) A little every so often can make a huge difference.
Keep on topping up whatever you’ve got left over at the end of every month, whether it is £30 or £300. If need be, set yourself a budget, so you can factor in saving wherever possible.
4) Set yourself savings goals.
It is easy to take the money out of an account, but you have to motivate yourself to keep putting cash in. Banks now offer online savings goal charts which will help you to track your progress and keep you incentivised.
5) Getting online will make saving much easier.
There is an array of online accounts that pay a decent rate of interest that will be much easier to operate than if you trudge down to your local branch or wait on the phone. This is particularly the case if you already operate your current account online
6) Only invest your Isa allowance in equities if you’re serious about investing. But if you’re nervous, stick to cash just now.
This option is only advisable for those in a much more secure financial position, as the possibility of losses is always there. You’ll also need discipline and nerve to stick it out in markets, which could be quite volatile in the short term. But the reason why investing can be such a canny option is that equities should outperform cash in the long term. I’m putting together a dummy’s guide to investing for young people, based on my experience so far as an investment writer; look out for this in the near future. If you’re really interested in getting started, research, research and research. Figure out what experts are recommending in terms of hot regions, asset classes and types of companies – for instance, emerging markets, like Brazil, China, Russia and India, are becoming hugely popular for funds and investment trusts that invest your Isa money. But you’ve got to figure out what your appetite for risk is, how much you want to invest and what certain providers will charge you, which isn’t easy to suss out yet it can really eat into your returns. It’s far from straightforward, so unless you’re really serious, play safe and stick to cash.