Ignore Isas at your financial peril, says JEFF PRESTRIDGE
We are living in financially challenging times. Bills and taxes continue to rise, while higher interest rates are a double-edged sword, providing financial comfort for savers but discomfort for homeowners with a mortgage.
At such times, it may seem appropriate to push long-term savings to one side. Indeed, for some, it is the only course of action available.
But, if you can, I urge you to keep an eye on the future and keep saving through thick and thin.
Options: Isas can be set up now and accessed when needs must – whether it’s to pay for the holiday of a lifetime, a new car or to top up our retirement income
Thankfully, while the nation’s finances and our own remain stretched, we have a Government that encourages us to save. It does this through giving us generous tax breaks on money we shovel into our company or personal pension. It also allows us to build wealth in an Individual Savings Account a form of tax-free wrapper.
While most of us are automatically enrolled by our employer into a pension plan, the same hand-holding doesn’t apply to Isas.
No one is going to push you into an Isa. They are for you to set up, fund and, at some point in the future, access when needs must whether it’s to pay for the holiday of a lifetime, a new car or to top up our retirement income. It’s up to you.
> The essential guide to Isas: What you need to know about tax-free saving and investing – and how to get started
I think Isas are hugely underappreciated. Maybe, it is because we have always been told pensions are the bee’s knees – a result of the fact we get generous tax relief on the pension contributions we make, as well as top-up payments from our employers.
But ignore Isas at your financial peril. As well as being a perfect savings complement to a pension, they offer a simplicity that pensions do not possess.
In a nutshell, see an Isa as your tax-free fortress to which no one but you holds the keys. Whatever you put into this financial fortification – cash, shares or investment funds – the taxman can’t come after a slice.
The result is that all savings and investment income earned within an Isa is tax-free. Furthermore, any capital gains from investments are tax-free.
Don’t be intimidated into doing anything beyond your normal risk tolerance – for example, when friends brag about the ballooning value of their Isa over a pint down the pub
So, when it comes to Isas, you can forget about impending cuts to annual tax-free dividend and capital gains allowances. And to put the icing on the cake, any withdrawal you make is not subject to tax (unlike a pension, where most withdrawals are taxable) or a minimum age being reached. Withdrawals are tax-free at any time of your choosing. All rather compelling, I would say.
So use an Isa to build tax-free wealth and financial independence in later life. Adults can stash away a maximum £20,000 every tax year April 6 through to April 5 the next year while children can put away £9,000.
These are generous annual allowances which I implore you to utilise even if, like me, there is no way you could tuck away the maximum permitted.
In terms of the Isa strategy you adopt, it really is up to you. The key is to be comfortable with the foundations of your Isa the risk to the underlying capital.
Don’t be intimidated into doing anything beyond your normal risk tolerance because of peer pressure for example, when friends brag about the ballooning value of their Isa over a pint down the pub. Do your own Isa thing.
With the Bank of England base rate standing at 4.25pc compared with just 0.1 pc in early December 2021 a cash-based Isa now looks rather appealing if it comes equipped with an attractive interest rate.
Some cash Isas that permit instant access are paying 3pc interest or more, while fixed-rate deals can be found above 4 pc.
Most of these top deals are being offered by building societies and specialist online-based savings institutions.
Keep an eye on This is Money’s best-buy savings rate tables for an up to-date run-down of the best rates.
Higher interest on cash savings held outside of an Isa means more people are having to pay tax on their savings income because their annual interest exceeds the tax-free personal savings allowance. This is currently set at £1,000 for basic-rate and £500 for higher-rate taxpayers. Transferring some of these savings into a tax-free cash Isa makes solid financial sense.
Long game: Stocks & shares Isas give you the opportunity to generate a mix of capital and income return over the long term
Stocks and shares Isas shouldn’t be ruled out
Although cash-based plans are the most popular type of Isa, stocks & shares plans should not be ruled out.
Indeed, you can mix and match them, putting a proportion of your contributions into a cash-based plan and the rest into another Isa that permits you to invest in shares, investment funds and stock market-listed investment trusts.
While the banking crisis in the U.S. and parts of Europe has unsettled stock markets – and may continue to do so – stocks & shares Isas give you the opportunity to generate a mix of capital and income return over the long term.
The best approach is to set up an online Isa with an investment platform such as AJ Bell, Bestinvest, Charles Stanley, Fidelity, Hargreaves Lansdown and Interactive Investor.
> How to choose the best (and cheapest) stocks and shares Isa and the right DIY investing account
You can then invest when you choose, how you want (for example, into direct shares, investment funds or a model portfolio designed by the platform) and according to your financial situation.
The only proviso is that you stick to the £20,000 annual limit.
Investing, rather than saving, also makes perfect sense as the foundation stone for a Junior Isa (Jisa), which can be set up by parents for their children. This is because of the long-time horizon involved – withdrawals from a Jisa cannot be made until age 18.
Yet, the rules of investing apply to Jisas in the same way as they do to stocks & shares Isas. That means spreading investments across investment funds – and contributing monthly, rather than through occasional lump sums.
Some platform providers such as Hargreaves Lansdown and Interactive Investor are going out of their way to court Jisa customers by cutting their fees to the bone. However, there is one final word of warning. If you are anxious about utilising this tax year’s Isa stocks & shares or Jisa allowances, you can put in some cash first – and then invest it when you have worked out where best it should be deployed.
In a financial services industry that’s not known for making things particularly simple for customers, Isas are as straightforward a proposition as you are likely to find.
They are a good financial habit that you should embrace with gusto.
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