While the current ISA regime was left untouched in the Spring Statement, it may only be a stay of execution – so make the most of your choices now, says Kay Hill
There was a collective sigh of relief from savers when Chancellor Rachel Reeves concluded her Spring Statement without acting on rumoured plans to reduce the amount that could be held tax-free in ISAs. But hidden deep within the supporting documents released after her speech, was a warning that there are changes ahead: “The Government is looking at options for reforms to Individual Savings Accounts that get the balance right between cash and equities to earn better returns for savers, boost the culture of retail investment, and support the growth mission.”
“Better returns for savers” sound good – but what the Chancellor wants is to persuade people to reduce the amount they save in cash ISAs and invest in stocks & shares ISAs instead. At the moment, 31% of adults have a cash ISA while just 16% have a stocks & shares ISA, yet it’s clear that for long-term savers, investing in the Stock Market almost always outperforms cash. The Investment Association and Opinium conducted research that found that if you had saved £10,000 into a cash ISA five years ago, although it would have grown in real terms thanks to the tax-free interest, the effect of inflation would have reduced the buying power of that money to £8,713 (this is known as “inflation risk”). If this same amount had been invested in a typical global equity fund via a stocks & shares ISA, it would be worth £12,249.
The problem with investing in a stocks & shares ISA (or any other form of stock market investment) is that not only are returns not guaranteed (there is no equivalent of an “interest rate”), you can also end up with less than you initially invested. For investors happy to put their money away for at least five years, the regular rises and falls of the market even out and almost always result in a greater gain – although it can take time. The FTSE 100 dropped 31% in 2008 as a result of the financial crisis and took a full two years to bounce back.
The five-year time period advised for investing in shares rather than saving in cash is especially problematic for first time buyers. Estimates of how long it takes to save for a first housing deposit vary from four years and one month (Mojo Mortgages) to 12 years (Uswitch), so you need to be really honest with yourself and look realistically at when you expect to be ready to buy, before selecting your ISA options accordingly. It is possible to hedge your bets and pay into both a cash ISA and a stocks & shares ISA in the same year, as long as you don’t put in more than £20,000.
Cash ISA
A cash ISA is simply a savings account where you don’t pay tax on the interest. It can be “instant access” where you can take money out whenever you need to, it may have a limited number of withdrawals a year or you may choose to lock your money in for a fixed term period. Ideally, look for a “flexible” ISA, as this means if you do need to draw money out in an emergency, that you can replace it within the same tax year. Interest rates can be variable, or fixed for a time period. Best buys currently include Trading 212, with unlimited withdrawals, paying 5.07% variable.
Lifetime ISA
The Lifetime ISA (LISA) was designed to fund a first home or retirement, and is restricted to paying in £4,000 a year. It can only be opened by those aged between 18 and 40, but can be paid into until aged 50. The Government adds a 25% bonus to your savings annually, up to £1,000 a year. You can hold cash or stocks and shares in a LISA. Because of the generous bonuses, you can only withdraw money to buy a first home, if you are aged 60 or over, or terminally ill. Emergency withdrawals carry a penalty of 25%.
To use the money towards a first home, you must be buying with a mortgage, your solicitor will receive the funds, and the property must cost £450,000 or less (frozen since 2017, when the average UK house price was £226,756). The average UK house price is now £269,000, reaching £564,000 in London and £386,000 in the South East, so it may no longer be suitable for many first time buyers unless the Government raises the cap. A J Bell calculated that in 39 areas of the country it was already impossible to buy a typical terraced home using the LISA, with the situation only getting worse by 2029, when LISA savers would be priced out of a further 23 locations, including Brentwood, Watford and Croydon.
For those considering buying using Shared Ownership, the price limit of £450,000 applies to the full market value of the property not the share purchased, reducing its helpfulness yet further. Current best buys for a cash LISA are Moneybox, 4.7%, and Tembo 4.6% (for stocks & shares see below).
Stocks & Shares ISAs
If you plan to save for five years or more, then you may want to consider a stocks & shares ISA. Unlike cash products, a variety of charges apply; a platform charge that can be a flat fee or a percentage of the value of your funds, a management charge (anywhere from 0.05% to over 1% of your fund a year), the costs of buying and selling shares and often a transfer-out fee when you withdraw your funds.
You can choose your own shares, or opt for a managed service (with actual humans or robo-investment), and select your preferred “risk level” – as with most things in life, greater rewards and greater risks go hand-in-hand. With so many variables it’s hard to compare providers, but Which? recently recommended both A J Bell and InvestEngine as offering a good balance of ease and value for money.
If you do invest in a stocks & shares ISA, then it is sensible to withdraw your money before committing to a house purchase. Market crashes can be caused by completely unforeseen events, such as the outbreak of Covid, and can be dramatic – in America’s Great Depression the Stock Market fell 79%, while in October 1987, the FTSE 100 lost 73% of its value; not something you would want to happen between exchange and completion.
Innovative Finance ISAs
Finally, there is one more ISA that can only be marketed to high-net worth and “sophisticated” investors because of its high level of risk, as it involves peer-to-peer lending and crowdfunding debentures (investing by buying business debt).
First Time Buyer is an exciting bi-monthly glossy which takes a stylish and comprehensive look at all the options available, setting them out in an entertaining and informative way, and helping potential customers navigate their way through what is often a daunting and complex process. We dispel the myths, reinforce the facts and arm the reader with the tools necessary to make their homeownership dreams a reality.
