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‘Should I put my savings in an ISA?’

Joanna Faith
Written By:
Joanna Faith
Posted:
Updated:
05/12/2014

Over the next few weeks, you’ll probably notice an upsurge in the amount of ISA-related content in the financial press.

This is because ISA season – a term coined by the financial services industry – is about to kick off.

ISA season is the two months or so leading up to the end of the tax year where banks and other providers launch attractive rates to incentivise savers to use up their tax-free ISA allowance.

So, should you be enticed by the ISA hype or not? We ask three financial advisers for their views:

Steve Martin of Smart Financial Planning

The answer is a resounding yes. Yes, as part of your wider financial planning an ISA is a great tool to use. It will work for you in one of two ways; either it allows you to receive tax free interest on your bank account savings or it allows you to avoid most of the taxation involved in hold shares or funds.

As a result of the original PEP product and the modern ISA there are now a number of individuals with over £1m in their ISA. These funds are free from capital gains tax, and most income tax. How I would love to be able to take £1m of clients’ money and drop it into and ISA wrapper. The more you use ISAs and the more you invest in them the more beneficial they become.

One significant drawback is that ISAs do not provide any mitigation from inheritance tax so care needs to be taken to ensure that the tax benefits of holding the ISA isn’t eroded by the inheritance tax considerations. The optimal amount of ISA assets versus the inheritance tax burden depends on individual circumstances but suffice to say, if you have less than the Nil Rate Band (currently £325,000 in total assets) you are safe to accumulate more in an ISA.

One final thought, ISAs are a great way to start making stockmarket-based investments instead of using a pension if you are fearful of locking money away in a pension. You could then transfer them (no CGT) into your pension at a later date when you had the confidence that you wouldn’t need access to money.

Jaskarn Pawar of Investor Profile

For shorter term savings, in these times of low interest rates, making sure you can earn tax free interest is a must. It is probably the first rule of saving at the moment. If you earn 2% interest on your savings, in an ISA you get 2%. In a normal taxed account a basic rate taxpayer would receive 1.6% net, a higher rate taxpayer 1.2% net and an additional rate taxpayer 1.1% net. In savings the name of the game is to get as much interest as you can and a cash ISA certainly helps you to do that.

Looking towards long term savings, then a pension is not always the best option, and certainly one of the least exciting options for most people. A stocks and shares ISA can work very well and provided that all important access to your money whenever you might need it. You can invest for long term growth and expect much better rates of return than cash will provide.

When you near retirement you could choose to invest a few lump sums into a pension from your ISA money to get the tax rebates. That is particularly beneficial if you think you will be a higher rate tax payer before retirement and a basic rate tax payer after retirement. Otherwise the option of tax free income from ISAs through retirement is pretty appealing.

Alistair Cunningham of Wingate Financial Planning

For those who are higher rate tax payers, and likely to retire as basic rate tax payers, pensions can be more appealing than ISAs – both have broadly tax-free growth on income and capital gains, but the pension receives up to 40% tax relief upfront, whilst paying a 25% tax-free lump sum and potentially only 20% income tax in retirement. This equates to a tax gain of crudely 25%.

For those who are basic rate tax payers an ISA may better suit. There are tax benefits in the pension, but not as much as for the higher rate tax payer; 20% effective tax relief is granted up front, but 15% tax would likely be paid in retirement (based on 75% at 20% and 25% which is tax-free).

After considering tax, another significant point is accessibility. Pensions are essentially inaccessible; after the 25% lump sum it is normal only an income can be provided, thus making ISAs a preferable route for many savers. Allowances of up to £40,000 p.a. are available into pensions, which can often be ‘Carried Forward’ up to three years, meaning lower earners may choose to save into ISAs until they go over the 40% threshold.