This month marked the 20th anniversary of the launch of the individual savings account (ISA) and, as with teenagers navigating adolescence, there have been some ups and downs.
Yet they remain an essential tax-efficient component of clients’ portfolios.
Those who maximised their ISA allowance every year since launch could have contributed £209,560 (plus TESSA-only ISAs and PEP transfers) and, if they had invested in the right collective investment fund, could be one of the alleged ISA millionaires.
According to the most recent HMRC statistics, at the end of 2017/18, there was £608bn in adult ISAs and £4bn in Junior ISAs, split 55% in stocks & shares (S&S) and the rest in cash, saving clients £2.9bn in tax relief.
However, the number of adult ISA accounts is at its lowest level in almost 20 years, reflecting a decade of low interest rates and the introduction of the personal savings allowance (since 2010/11 the number of cash ISAs has fallen by 35%).
Yet the average subscription in 2017/18 has increased by 60% into cash and, into S&S, it's more than doubled to £10,124.*
How have ISAs developed?
Since Gordon Brown introduced them in 1999, ISAs have undergone a number of changes, from their early days as maxi and mini, cash, S&S or life insurance ISAs to their current guise. The ISA allowance has risen from £7,000 to £20,000, and a range of new ISAs and options have launched, making them available to first-time buyers, pension savers and savvy investors.
Due to low uptake, the life insurance element of early ISAs was abolished in April 2005 and, to further reduce confusion, three years later, the maxi and mini distinction was also removed. In its place was an overall limit on the amount that could be invested into cash or S&S ISAs.
From July 2014, all ISAs became NISAs (New ISAs), with the flexibility to save a total of £15,000 annually in cash and/or S&S ISAs. The NISA rules also allowed the transfer of previous years’ ISAs freely between S&S and cash ISAs.
Inheritable ISA rules were introduced in April 2015 (and updated in April 2018), meaning an individual can inherit the value of their deceased spouse's or civil partner's ISAs.
Known as the ‘additional permitted subscription’, it is based upon the (hopefully) higher ISA value at the date of closure (after estate administration) rather than at the date of death, and is in addition to the surviving spouse or civil partner's own ISA allowance, thereby preserving the tax-efficiency of a couple's ISA portfolio.
However, many people still overlook the fact that ISAs form part of an estate on second death and could be subject to inheritance tax. Whilst AIM shares ISAs attract business relief after two years, they are often not appropriate to clients’ attitude to risk or capacity for loss.
So an alternative is to use a whole of life protection plan, written on a joint life second death basis in a discretionary trust.
In April 2016 the Innovative Finance ISA was launched. This is a cash ISA, where higher rates of interest are generated from crowd-funding and peer-to-peer lending to borrowers, which could be individuals, businesses or property developers.
Though there are about 40 providers, uptake has been low with only £290m invested, due to the product’s specialised nature and higher risk.
Many clients are unaware of the Flexible ISA rules introduced from April 2016, or their benefits.
Though ISAs already provide flexibility of withdrawals, these rules allow clients to withdraw money from the cash element of their ISA (only applies to: cash, Innovative Finance, Help-to-Buy and S&S) and replace it within the same tax year, without it counting towards their ISA allowance.
Withdrawals can be made from current and previous tax years’ ISAs, and the ISA provider will track any payments and withdrawals, but the client is ultimately responsible for ensuring they don’t exceed their ISA allowance and only have one type of each ISA.
The Zurich Intermediary Platform facilitates Flexible ISAs, providing clients who need short-term access to money or who are looking for a regular (retirement) income within a tax-efficient vehicle to dip in and out of their ISA without using up their ISA allowance.
Helping first-time buyers and pension savers
The Help-to-Buy ISA was introduced in December 2015 as a way to ease the UK’s housing crisis and to help first-time buyers.
It offers a government bonus (on completion of buying a home) of 25% on savings up to £12,000. However, they are due to close from December 2019, being replaced by the Lifetime ISA (LISA), which launched in April 2017.
Anyone aged between 18 and 40 is entitled to open a LISA and save up to £4,000 a year until age 50. The government pays a 25% monthly bonus, up to a maximum of £1,000 a year. A LISA can only be used as a deposit towards a first home or from age 60 for retirement, otherwise a 25% penalty applies to money withdrawn.
However, it is for retirement that a LISA could be most beneficial. If a client saved the maximum each year from age 18 to 50 (spanning 33 tax years), including the bonus, they could build up a pot of £165,000 plus growth.
In comparison with a pension, a basic rate taxpayer saving £4,000 a year net (£5,000 a year with tax relief) and not retiring until age 60, would be better off in a LISA because the proceeds are not taxable.
Saving for the next generation
George Osborne’s Junior ISA (JISA) launched in November 2011, for children under the age of 18. It replaced the Child Trust Fund and allowed parents, grandparents or friends to save £3,600 a year (at launch) for the child, who cannot access it until they reach 18.
Since their launch, £4.1bn has been invested in junior cash and/or S&S ISAs, and their number has increased year on year.
Someone born in November 2011 could have £35,836 saved for them (including the 2019/20 allowance of £4,368). Assuming inflationary increases in the allowance of 2% a year to 2029/30, this would rise to approximately £84,484 plus growth.
The table below shows what the potential value might be at age 18, based on various contribution levels/methods and growth rates...
|JISA subscription total saved
||Value at 1%
||Value at 3%
||Value at 5%
|£3,600 one-off lump sum on birth
|£3,600 lump sum each year (£68,400)
|Maximum lump sum each year (£84,484)
|£150 per month for 18 years (£32,400)
|£250 per month for 18 years (£54,000)
Growth rate is after charges and value assumes monthly compounding
The great intergenerational wealth transfer of trillions of pounds has been well publicised and JISAs provide parents and grandparents with a tax-efficient vehicle with which to pass across some of that wealth in a controlled way, during their lifetime.
As the figures show, the compound growth effect helps generate a significant sum, which could at age 18 be transferred into an adult ISA (note – children can also take out an adult cash ISA from the age of 16) or use the money to fund learning to drive, university fees, travelling, or a house deposit.
ISAs have developed and matured over the last 20 years, but whilst increased flexibility and choice is good, it brings added complexity for clients.
Many don’t understand ISA transfer rules, let alone inheritable or Flexible ISAs, and though the Help-to-Buy ISA is closing, the LISA has been slated for muddying the waters between pensions and ISAs. To top it off, there’s a rumour of an IHT-exempt Care ISA in the upcoming Social Care Green Paper.
However, ensuring that clients of all ages fully utilise their tax-efficient ISA allowance across the most appropriate ISAs continues to be essential.
Investors and savers have never had more choice, so whether they are saving for capital growth, retirement, a first home or their child’s or grandchild’s future, there’s an ISA out there to suit them.
Andy Woollon is wealth specialist at Zurich UK
*Source: HMRC ISA statistics Aug 2018
The figures and tax rates in this article were correct at the time of publication