Taking out an ISA is an ideal way of putting your savings to good use. So, what exactly are the core ISA benefits? In this article, we’ll explain exactly what an ISA is, which one to choose depending on your circumstances, and the benefits of opening one over the long term. To find out more, please read on.
What exactly is an ISA?
The acronym ISA stands for Individual Savings Account. It is a tax-efficient vehicle that allows investors to save and invest up to £20,000 per tax year. There are five common types of ISA:
- A Cash ISA
- A Stocks and Shares ISA
- An Innovative Finance ISA
- A Junior ISA (JISA)
- A Lifetime ISA (LISA)
The £20,000 tax-free allowance is the total sum you can invest annually in a single ISA, or across all types, except one – the junior ISA, where the annual tax-free allowance is only £4,000.
The one thing you should be aware of is that if you do not use all of your annual allowance for any given tax year, you cannot carry it over to the next year, unlike the annual allowance for pension contributions. With ISAs, it’s a case of use it or lose it.
Which is the right ISA for you?
When it comes to deciding which ISA is right for you, it all depends on your personal goals and how much risk you are willing to take on. Here are a couple of questions you will need to ask yourself in order to identify the right ISA for your goals.
Ask yourself why you want to save
The first thing to get to grips with is your motivation for saving. What are your targets? What are you looking to achieve? Are you thinking long-term or short-term? Will you be putting money away every month, every year, or in one lump sum?
You also need to consider whether or not you will need regular access to your funds or whether you are prepared to lock it away for your retirement. For longer-term investments, we will look into what are the benefits of a Stocks and Shares ISA in due course.
How risk-averse are you?
The two most common types of ISA are the Cash ISA and the Stocks and Shares ISA. The key difference between these two is that, while a Cash ISA works in much the same way as a traditional savings account, a Stocks and Shares ISA works by investing your funds into various assets with a view to achieving financial growth over the long term.
We will look into the Stocks and Shares ISA benefits shortly, but first, a brief word about risk. Whereas money saved in a Cash ISA is relatively safe, the funds you invest in a Stocks and Shares ISA can go up or down. So it really all depends on your attitude to risk.
What are the benefits of a Stocks and Shares ISA?
The ISA benefits are numerous, depending on the type of ISA you decide to take out, but the main benefit with all of them (apart from the JISA) is the £20,000 per year tax-free concession.
The problem with ordinary savings accounts, and this also applies to Cash ISAs, is that the interest rates they earn are very low. But one of the biggest benefits of Stocks and Shares ISA accounts is that they have the capacity to outperform Cash ISAs significantly in the long term. It all boils down to that horrible four-letter word – risk.
The other name for a Stocks and Shares ISA is an Investment ISA, with “investment” being the operative word. A Cash ISA is not an investment as such; it’s akin to a savings account. With an Investment ISA, however, you are investing your money into stocks and shares. For some people, it is this that puts them off when they think about the potential volatility of financial markets.
When considering the Investment ISA benefits, you have to look at the bigger picture. The full list of advantages includes:
An easy way to begin investing
Many people shy away from the thought of opening a Stocks and Shares ISA because they think that dealing in equities is too complicated. However, with the arrival of robo-investing services and digital investment products, this is no longer the case. They do all the hard work on your behalf.
A robo investor will build a portfolio to suit your individual needs and will do the necessary legwork in terms of monitoring and changing your portfolio when and where appropriate. If you’re going down the DIY route, this allows you to spend more time doing the things you like to do, while your robo-adviser does the hard work managing your account.
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The ability to keep more of your returns
UK residents pay two taxes on their investment returns – Income Tax and Capital Gains Tax. One of the S&S ISA benefits, as previously explained, is that you are given an annual ISA allowance of up to £20,000. These contributions are not taxed, nor are any returns that they make.
So another of the Investment ISA account benefits is that not only do you get to keep more of your hard-earned money, but you also spend less time putting together a self-assessment tax return.
Delivering higher returns
Although there have been some small increases in recent months, the interest rates on cash savings here in the UK are still poor. Typically they remain under 2%. In spite of that, Brits keep on putting their money into Cash ISAs.
From the point of view of easy accessibility, to be able to pay unexpected or emergency bills etc, the use of Cash ISAs is clear. However, by putting all of your money into this type of savings account, you are not taking advantage of the amount the potential interest your money could earn for you in the long term.
The fact of the matter is that, with inflation peaking a little bit above the bank of interest base rate, the value of money tied up in savings accounts is likely to decrease in real terms. In other words, your money is underperforming.
Left in limbo like this, your long-term financial targets may never be fully realised.
The advantages of ISA investments in stocks and shares is that rather than relying on a low fixed interest rate as with a Cash ISA, you can reap the reward of how much your stocks and shares investments are worth when it comes time to sell them. While there is a risk that you might have to settle for less than you originally invested, there is also an excellent chance of making inflation-beating returns over time.
Is it worth taking out a Stocks and Shares ISA?
Now we’re coming down to the crunch. There is an awful lot of scaremongering going around, and this has to be put into perspective. Is it really worth taking out Stocks and Shares ISAs? Well, one way of answering that question is to look back over what has happened in recent years.
According to the moneytothemasses website, the recent history of Stocks and Shares ISA performance is actually very encouraging.
In the tax year 2017/2018, Stocks and Shares ISAs showed a return on investment of 4.8%. In the following tax year, 2018/2019, the figure was 4.04%. To put that into perspective,we need to compare that to Cash ISA performance. The average interest rate for both fixed and variable rate Cash ISAs was only 1.01%. Put them side by side and the significant advantage in favour of the Stocks and Shares ISA begins to show.
The Covid-19 variable
There are always fluctuations in the world of economic markets, and there always will be. Once upon a time, there was the Wall Street Crash, then there was the subprime mortgage crisis between 2007 and 2010, when the bottom fell out of the markets.
More recently, of course, there has been the Coronavirus pandemic, and indeed it is far from over, although we can now see a light at the end of the tunnel – at least here in the UK.
The great thing is that, generally speaking, financial markets have always recovered. They might take time to do so. This is why it is always recommended that Stocks and Shares ISAs should be considered as long-term investments. If you don’t have to access your funds during times of financial crises, your portfolio will likely weather the storm.
Having a competent professional wealth adviser in your corner is a big plus.