Ten ISA myths exposed
ISAs have evolved radically in the 20 years they’ve existed and in that time many myths about these tax-free savings products have emerged.
Sarah Coles, personal finance analyst at Hargreaves Lansdown, tackles some of the most common untruths.
With Brexit imminent, I should wait and see before opening an ISA, just in case
If you wait until after April to see what happens, not only is there no guarantee you will have any more clarity on the political future, but you’ll have missed out on this year’s ISA allowance too.
It’s hard to predict exactly what impact Brexit will have on the market, but not every stock will behave in exactly the same way. Some companies are plugged into the domestic economy, so will profit from a positive Brexit deal. Meanwhile, others make a large percentage of their profits overseas, so will do better in the event of a disorderly Brexit. Keeping balance and diversification means whichever way the Brexit pendulum swings, your portfolio can handle it.
In the short term, the markets will react to whatever kind of Brexit we get, but this shouldn’t frighten the horses: dips in stock market prices are part and parcel of a normal financial cycle, and investors shouldn’t let this derail their long term goals. One sensible approach is to put your money into a stocks and shares ISA now, in cash. Then over time you can drip-feed your money into investments. That way you can take advantage of this year’s allowance: when prices fall you’ll be able to buy more units, and when they rise, you’ll benefit from the gains.
I don’t need to protect my savings from tax because I don’t pay tax on them anyway
The introduction of the personal savings allowance in 2016 understandably led to questions as to whether it’s worth bothering with a cash ISA any more. You don’t pay tax on the first £1,000 of interest if you’re a basic rate taxpayer (£500 for higher rate taxpayers, and £0 for additional rate taxpayers), and with many cash ISA rates so low, earning more than this doesn’t seem terribly likely. It’s one reason why over 1.5 million fewer cash ISAs were opened the year after the allowance was introduced.
For a basic rate taxpayer with modest cash holdings, you won’t save any tax today by using an ISA: the key is what you could save further down the line. You can put £20,000 into an ISA this year (so a couple can put away £40,000), and the tax savings on ISAs accumulate as your savings build. These savings will be magnified if interest rates rise, you move tax brackets, or the savings allowance is cut. By using a savings account you might be reasonably sure you won’t pay tax on your savings this year. By using an ISA, you can be sure to protect your savings from tax forever.
The interest rates on cash ISAs are so poor, they’re not worth bothering with
The rates on cash ISAs have improved in recent months, but the best rates still fall slightly below those available on savings accounts. However, rates won’t be at rock-bottom forever. By putting cash into an ISA, when rates eventually rise, you could have built up enough savings to make a significant sum in interest – which is protected from tax forever. You could argue that you can build the money up in savings accounts, and switch when interest rates improve. However, you have no way of knowing whether the ISA allowance will allow you to do this further down the line.
In addition, if you save in a Lifetime ISA, you get the government bonus on your contributions. If you put £4,000 into an ISA before April, you’ll get a £1,000 top-up from the government – which is the kind of uplift that any saver would give their eye-teeth for.
I don’t need to protect my investments from tax, because I don’t pay tax on them either
We can all end up paying tax on our investments if we’re not careful, because even non-tax payers can pay capital gains tax if they bust the annual limit (£11,700 this year).
When it comes to dividends, meanwhile, this may have been the case a year ago, when the dividend allowance was £5,000, but a cut to £2,000 last April (and a surge in dividends) has changed the picture entirely. Before the cut, you could hold around £135,000 of UK shares outside an ISA before paying any tax on dividends: today it’s just over £46,500. And there’s no guarantee that the dividend allowance won’t be cut again in future, shrinking this figure even further.
Huge changes over such a short period of time underline the value in investing through an ISA. It means that regardless of what happens in future, you are protected from tax on dividends and capital gains tax forever – and this in turn gives you a great deal more flexibility over how you take profits in future.
My money is tied up in an ISA
If you have money in a stocks and shares ISA, it’s recommended that you invest for the long term of 5-10 years or more. However, if your plans change, it’s not tied up, so you can access the money. Likewise a cash ISA, unless it is fixed for a term or has a notice period, can be accessed at any time.
Once I’ve opened an ISA, I’m stuck with it
You have always been able to make some transfers, and since 2014, you have had even more flexibility. You can now switch between cash and stocks and shares ISAs (and back again). You can switch previous years ISAs without affecting this year’s allowance, and consolidate your ISAs with one provider to make it easier to manage. Just check your new provider accepts transfers in.
I’m too old for a stocks and shares ISA
Stocks and shares are long term investments. However, even if you were to start investing at an older age, there’s no need for your family to cash it in in the event of death. It will form part of your estate, so will be considered when it is being assessed for inheritance tax, but your spouse will inherit an allowance equal to your ISA holdings (known as an Additional Permitted Subscription). It means they can wrap exactly the same investments into this allowance, and continue investing for the long term. Of course you still do need to consider your investment horizon and when you might need to draw on your ISA, if at all, at older ages.
My children are too young for an ISA
You can open a Junior ISA for a child from the day they’re born. They’ll get their nest egg at the age of 18, but that doesn’t mean you should wait until closer to the time. The earlier you start, the more you will benefit from compounding – where you have the potential to see growth on your growth. And because you’ll be putting the money away for the long term, you’ll be able to invest rather than use a cash JISA – which radically improves your chances of seeing better growth over 5-10 years or more.
In the early weeks and months it may seem impossible to imagine being able to put this money away, but family and friends will be keen to celebrate your new arrival, so rather than collecting sleepsuits they’ll grow out of in five minutes, you can ask them to contribute to the JISA, and help provide them with something really valuable.
I’m not planning to buy property for a while – so it’s not worth opening a LISA now
There are two time limits that mean it’s worth opening a LISA as early as possible. Over the short term, you need to have had it open for 12 months before you buy a property, so it’s worth getting the clock started. Over the long term, once you reach the age of 40 you can’t open a LISA, but if you open one with a small sum at the age of 39, you will still be able to contribute to it until you are 50. Getting started now will protect your right to a LISA.
There’s no need to think about this until the end of the tax year
One in six people with ISAs don’t get round to putting money into an ISA until the very end of the tax year. This is definitely better than not getting round to it at all – and losing that year’s ISA allowance. However, by investing at the start of the tax year, you benefit from the potential growth during that year – as well as giving your money longer to ride the ups and downs of the stockmarket. If you already have investments outside an ISA, moving them into an ISA wrapper at the beginning of the tax year also means doing so before you earn dividends on them – and rack up a potential dividend tax bill.