Does the Isa entice ya? The lowdown on your tax-free allowance

As a new financial year gets underway, we ask whether the ISA season is all that seductive to young people and what YOU can do with your tax-free allowance

Iona Bain

So it’s April and that can only mean one thing – it’s the Isa season!

Maybe it’s not ringed in red marker pen in your calendar like the latest ‘drop’ from Kylie Jenner. Okay, maybe that isn’t either…and maybe you don’t even have a calendar anymore!

Yea, I need to get with the programme. But then so do the financial media, because it seems we’re all acting like its 2012, when Brexit was merely a fanciful notion and Harvey Weinstein still had a career. Ahem, let’s move on…

The ISA – or Individual Savings Account – is 20 years old and it has now become the lodestar of the personal finance universe. That’s because it is the only way you can save or invest money without having to pay tax. (Well, unless you’re a millionaire celebrity and have a cunning tax adviser on speed dial).

It’s not really an account – it’s actually more like a wrapper or an envelope that HMRC doesn’t see. Financial writers and commentators sometimes describe it as a vehicle, but that slightly sets my teeth on edge. It’s not a product in and of itself, as it is a government initiative, but many products can place themselves inside the ‘wrapper’ if they follow the rules

Sheltering your money from tax, while not exactly simpatico with hardcore Corbynism, that does make a big difference, long-term, to our financial bottom line. This is partly because capital gains tax can REALLY add up when you start making money on your investments and partly because compound interest really is a wonder of the world. Like Einstein said, Well, he didn’t. But hey. Someone did. And it could have been Einstein!

The ISA red herring

We all get an Isa allowance every tax year, which starts on 5 April. Its currently £20k and we get a fresh batch every year. Unfortunately, if we haven’t managed to use up last year’s batch, we can’t carry it forward – it expires on 4 April, gone FOREVER.

So naturally, the financial industry spends a lot of money on marketing at this time of year, trying to persuade us to stuff our Isa envelopes with as much cash as possible before 5 April. I wonder why!

Of course, if you are in a position to save up to £20,000 into an Isa, then go you. Most young people aren’t. So – as I have long maintained on the blog – the whole Isa season rush is a bit of a red herring for my generation.

Bigger…but not necessarily better

The Isa, in many ways, is better than it used to be (although the advertising used to be a LOT more cringe…remember this howler!?)

When this advert came out, the Isa allowance divisions were mind-meltingly complicated. You could could save X amount into a cash one but only if you saved less than x amount into stocks and shares and…ARGH! It was absurd. Now, there is a simple £20,000 limit, and you can (more or less) put it into whatever you want.

And boy there’s a lot more choice than there used to be. You’ve got your basic cash Isa, then stocks and shares if you want to be more adventurous. But on top of that, we have the Lifetime and Help to Buy Isas for property savers (though the latter will end this year) as well as the Innovative Finance Isa, which allows you to lend money and earn a return, peer-to-peer style.

All options have their advantages and drawbacks. But while the choice of Isa strategy has improved, the underlying quality of the products hasn’t. In fact, for the lower end of the market (i.e. folks like us who can’t save an awful lot), things have got worse.

Recent research from easyMoney shows that those who used cash ISAs last year actually LOST money in real terms. The average rate on a cash ISA was just 0.81 per cent last year, while inflation stood at 2.5 per cent. This meant we lost a total of £4.7bn in value. Yikes.

The Isa divide emerging…

Broadly speaking, when it comes to Isas, there is only one game in town for younger people. Well, two.

The Help to Buy Isa has been lapped up by young people – more than 1.2 million of them, in fact. It is being phased out in favour of the Lifetime Isa, which has been less successful (partly because the financial industry is largely very snooty about it).

There ARE good reasons to be cautious about these products. The Help to Buy Isa won’t let you have your bonus until you’ve completed your contracts on your home, which has proven very problematic for buyers when they have needed to produce their full deposit at the point of exchanging contracts. The Lifetime Isa doesn’t do this – it pays you the bonus every month – but it does have a penalty for withdrawal, which is vicious. And both fuel demand for housing, making it a more precarious asset, exacerbating the struggle for first-time buyers and giving the government fewer incentives to reform our housing market.

But leaving those issues aside, it’s easy to see why the Help to Buy and Lifetime Isas go down well: they were designed with a specific goal in mind – property – and offer a juicy government bonus of 25 per cent besides the tax-free draw.

via GIPHY

Otherwise, Isas are not on young radars for a few key reasons:

💷 We are mostly focused on short-term “urgent” financial concerns, such as rent and debt. Saving is seen as a desirable but ultimately optional luxury.

💷 We tend to adopt a “screw it, let’s live” mentality when we see demoralising headlines about the impossibility of buying a first home and the pensions funding crisis.

💷 Millennial wages have been continually depressed in recent times. Not only do they have less money to save, we less to gain from tax-free accounts, particularly since the personal tax-free allowance has kept rising.

💷 Young people are not routinely taught what an Isa is and how they could use one. Personal finance education is patchy and the UK’s culture does not favour openly discussing personal finance in a healthy, constructive way.

💷 Rates on cash Isas are still abysmal so there’s no real reward for saving into them. You’re then left with a big leap up to Innovative or Stocks and Shares Isas, which present risk, commitment and the need to take big responsibility. Only a minority of young people would be willing and able to take that on.

But let’s cut the Isa some slack

I’m not sure that the Isa per se is at fault. Young people have less money than older people and do not think about the future as much – that’s just a fact of life.

The Isa will become much more relevant to them as they earn and save more. Yes, the Isa world may be bigger and more complex now, but it also offers more choice and room to manoeuvre (for instance, you no longer have those abusurd rules about how much you can invest in cash versus stocks and shares – the £20k is more or less an Isa free-for-all).

That combined with an undoubted appetite for the Help to Buy and Lifetime Isas (despite their peccadillos) as well means I’m not despairing.

Investing apps can create a sexy shortcut to the benefits of an Isa – the likes of Moneybox trade on the appeal of millennial-friendly brands like Apple and Disney, rather than the limited profile of the Isa itself  among young people. But young people need to have a solid grasp of how investing works. Only then can you make more informed decisions, whether that’s to track the markets at lower cost or to invest in more ethical companies. Digital wealth managers take the thinking out of investing – but they can take the choice out of it too.

Sussing out your Isa strategy

What does all this mean for your Isa strategy? The long and short of it is…if you can do something meaningful with your Isa allowance, go for it.

The Isa is particularly beneficial if you tick the following boxes:

🤔 You’re a basic or higher rate taxpayer but you reckon you’ll be able to save more than £1000 this financial year, either for a first home or another longer term goal.

🤔 You’re ready to start investing money that (in the worst case scenario) you could afford to lose, having already built up a decent savings buffer.

🤔 You’re frustrated with savings rates generally and want more bang for your buck.

🤔 You’re an additional rate taxpayer. Make it rain!

I can’t advise you on exactly on what kind of Isa to go for – it really depends on your circumstances and (more importantly) an honest assessment of your attitude to risk.

Are you genuinely comfortable with the prospect of losing money? It’s a big leap from cash Isas, which are thankless but low risk (apart from the LISA versions) to Innovative or stocks and shares, where you stake your money on businesses, companies or funds that may do well…or may not.

Of course it helps enormously to do your research, diversify and be patient. Don’t put all your prospective Isa money in one product, one fund or one strategy. If it goes wrong, you’re stuffed.

Remember that you’re not covered by the Financial Services Compensation Scheme beyond most mainstream cash Isas, so you’re taking on more of the risk if the company administering your Isa collapses. It can and does happen, though it is the exception rather than the rule.

Above all, make sure you have your three broad time frames nailed down – short, medium and long-term. Neglect one at the expense of another, and your finances will be seriously out of kilter.

My broad recommendations are:

➡️a Help to Buy Isa if you’re buying property soon (in the next year or so) or a Lifetime Isa for longer-term property saving

➡️The best-paying easy access Isa you can get if you haven’t got your basic savings pot in order

➡️Peer-to-peer options under the Innovative Isa umbrella if you’ve got your basic savings sorted and are craving a better return on your medium-term savings. Stick to mainstream providers with a proven track record and start with conservative returns, which will still be tastier than basic cash Isa rates but open you up to less risk.

➡️Stocks and Shares Isa for those ready and able to invest. You can either track the markets, pick your funds through a DIY investing platform OR leave it up to a digital wealth manager to take care of things. It is not my place to recommend one over the other, but I will be doing a deep dive into these options – as well as P2P – over the coming months on the Young Money Blog. In the meantime, weigh up your confidence…at a very base level, if you’d like to have direct oversight of your investments, with the possibility of getting a much better return if you get things right, go for a DIY investment platform and start to get a feel for active investing. If you haven’t got the time or appetite to do this, tracking the markets or (for a big shortcut at a higher cost) a digital wealth manager might be better for you.

This certainly isn’t my last word on the matter – for starters, check back this week for more of my thoughts on investing. In the meantime, a very happy new financial year to you all!

What do you think – are you that fussed about the new Isa season? Got your picks sorted? Will you be hitting your limits this year? Let me know by leaving a comment or tweeting @ionayoungmoney.

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