Are you ready to switch to an investment Isa?
Banks and building societies followed suit, slashing the interest they paid on their savings accounts. With the average rate on a tax-free cash Isa falling below 1% for the first time, cash savings don’t seem appealing. So is it time to move your cash into investments for better returns?
“August’s cut in the base rate prompted a big increase in the numbers of people transferring their cash individual savings account (Isa) to a stocks and shares Isa,” says Danny Cox, a chartered financial planner at Hargreaves Lansdown. “Yields (the income returns) on popular equity income funds and FTSE All Share index tracker funds are over 3% and far more attractive than cash Isas.”
If you want your savings to retain their Isa status, but the money to give you higher levels of income, you could switch to an innovative finance Isa (IF Isa) or a stocks and shares Isa.
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Your options for higher income
An IF Isa allows you to place peer-to-peer lending within an Isa wrapper, so your returns are tax-free. Peer-to-peer lending is where you lend your money directly to individuals and small businesses via a peer-to-peer platform.
With interest rates as high as 8.7% a year, an IF Isa is certainly tempting. However, your money would no longer be covered by the Financial Services Compensation Scheme, which protects up to £75,000 held on deposit in a cash Isa in the event of your bank or building society going bust. So with an IF Isa, you are taking on the risk of losing some or all of your money in return for that extra income.
Within a stocks and shares Isa, you can hold a variety of stock market investments, such as company shares and investment funds. The Isa wrapper enables them to grow free of income and capital gains tax and with minimal dividend tax.
The most popular equity income funds offer high yields (income returns on the investments). An example is CF Woodford Equity Income fund, one of Moneywise’s First 50 funds for beginners, which has a yield of 3.4%.
“Stock market investments are not for the faint-hearted or for the short term – less than five years – as the value of your investment will fall as well as rise,” says Mr Cox. If you aren’t sure whether you can take the higher risk, then you should consult an independent financial adviser.
How to transfer the money
If you do decide to move your cash Isa savings into an IF or investment Isa, there are several things to consider. Firstly, are your cash Isas fixed-term? If they are, you could face a financial penalty for transferring your cash before the term is up.
Secondly, how much money do you want to move? If you have cash Isa savings that you have built up in previous tax years, then you can transfer as much or as little as you like to an IF Isa or Stocks and Shares Isa – allowing for minimum and maximum investment rules set by the Isa provider. But if you have opened a new cash Isa in the current tax year, then you have to transfer the whole amount and close the existing account.
Just remember if you withdraw money from your Isa it loses its Isa status and will count towards your annual allowance if you deposit it back into an Isa.
The next thing to consider is where you want to move your money. At present, the Financial Conduct Authority has only approved a handful of peer-to-peer firms to provide IF Isas.
These include Abundance, Crowdstacker and Crowd2Fund, firms that are generally seen as crowdfunders rather than peer-to-peer lenders. But there are more than 50 other providers waiting to have their licences approved.
Given that you can earn up to £1,000 a year tax-free using your new personal savings allowance, you may want to stick to a standard peer-to-peer account for now so you can go with one of the major providers, until they launch IF Isas. Moneywise’s top picks for beginners are Zopa, Lending Works and RateSetter.
If you want a stocks and shares Isa, then you need to decide which investment Isa platform you want to go with. To make this decision, you’ll need to weigh up the different fees and charges levied by the Isa platform as well as the array of investments on offer – some offer investment funds only, while others offer company shares too.
Once your money is in the investment Isa on your chosen investment platform, you will need to decide which funds to buy. Rather than investing it all in one go, which can leave you vulnerable to buying at the top of the market, consider drip-feeding it into the funds on a regular basis over a period of time.
This lowers your risk by help smoothing out any peaks and troughs in the stock market, plus it enables you to buy fewer investments when prices are high and more when prices are low.
For investment platform recommendations and advice on using them, whether you’re a beginner or more experienced investor, visit our guide to the best investment platforms for beginners.
Once you’ve decided which investment or IF Isa you want to transfer to, you need to contact that firm and apply for an Isa, stating that you want to transfer in existing Isa savings. The Isa provider will then arrange for your savings to be moved so that they don’t lose their Isa status.
Whatever you do, don’t withdraw your Isa savings with the intention of paying them into your new account. Once money has left an Isa, it loses its tax free status and if you pay it into another Isa it will count towards that year’s allowance.
It’s good to know you can change your mind if you find investing is not for you. A change to the Isa rules in 2014 means you can transfer money held within a stocks and shares Isa into a cash Isa. Just follow the Isa transfer rules and get your new cash Isa provider to transfer the money.
|Type of Isa||Provider/investment fund||Annual income|
|Instant access cash Isa||The Coventry||1.1%|
|Fixed-term cash Isa||Metro Bank 5 year bond||1.5%|
|Innovative Finance Isa||Crowd2Fund||8.7%|
|Innovative Finance Isa||Crowdstacker||7%|
|Stocks and shares Isa||CF Woodford Equity Income fund*||3.4% yield|
|Stocks and shares Isa||Artemis Global Equity Income fund*||3.1% yield|
* Member of Moneywise's First 50 Funds, source: Moneywise, 29 November 2016.
Finally, if you are anxious about abandoning your cash Isas, remember that you shouldn’t dump them completely. Stocks and shares Isas are for long-term savings – no less than five years ideally – and IF Isas are designed for longer term savings too. You should keep your emergency savings pot in cash so you can access it in a hurry, without fi nancial penalty.
Putting money into an Isa
Each tax year, you can put money into one of each kind of Isa. The tax year runs from 6 April to 5 April.
In tax year 2016/17, you can save up to £15,240 in one type of account or split the allowance across two or three types. For example, you could save £10,240 in a cash Isa, £2,000 in a stocks and shares Isa and £3,000 in an innovative finance Isa in one tax year.
Your Isas won’t close when the tax year finishes. You’ll keep your savings on a tax-free basis for as long as you keep the money in your Isa accounts.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
The ISA rules allow investors to transfer money from an uncompetitive savings account with one provider into one from another provider that pays a better rate of interest. The bank to which you are transferring the money must do the transfer process, as withdrawing the money from the ISA wrapper means you lose the tax-free status. You can transfer a cash ISA into a stocks and shares ISA, but not the other way around and the current tax year’s cash ISAs must be moved whole to a single provider, but previous years’ ISAs can be split between new providers.
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.