The Isa’s new incarnation, the Nisa, is a big improvement. Used wisely, it will shield even more of your money from the taxman, says Ed Bowsher.
The individual savings account (Isa) has been around since 1999, and has proved very popular with investors and savers. Now the government has made it even better.
From 1 July the Isa we know and love became the ‘new’ Isa, or Nisa – and it’s a big improvement. You can now shield even more of your savings from the taxman, and there are even fewer restrictions on what you can invest in.
So, how do Nisas work, and what should you be doing with this new freedom?
How the Nisas work
Under the previous Isa regime you could open one cash Isa and one stocks and shares Isa each year. The cash Isa is basically a savings account where no tax is paid on any interest.
The stocks and shares Isa lets you invest in a range of assets (not just stocks) without being liable for capital-gains tax (CGT) on any profits, and means higher-rate taxpayers pay less income tax on dividends. Up until this month the annual limit on Isa contributions was £11,880, of which no more than half could go in a cash Isa.
But now the annual limit has gone up to £15,000, which can be split between cash and investments as you wish. You can also move money freely between cash and investments, whereas before there were restrictions on this.
So, say you’ve already opened a cash Isa and a stocks and shares Isa for this tax year, and that you’ve paid a full £5,940 into each.
These have now automatically become Nisas, and you can now top up the accounts to a total of £15,000 between them. Also, if you wanted to, you could shift the whole £15,000 into cash. Any Isas from previous years become Nisas too – you can’t pay any extra into these, but you can switch money out of stocks and shares and into cash if you wish.
What you can put in your Nisa
As far as we’re concerned, anyone with savings should have an Isa. The tax benefits are well worth having. Even if you’re currently a basic-rate taxpayer, that might not always be the case, and over the long run you’ll be glad of the CGT protection. The question is what to put in it. Cash is obviously the low-risk option, but the rewards are currently
very low.
Several banks have even cut the rates on their cash Isa offerings in recent weeks. That’s partly because it’s likely that a lot more money will flow into these Isas in the near future – this higher level of demand gives providers the opportunity to reduce the rates they pay out. So when you look at the top-paying accounts, you may be disappointed by the rates on offer. What’s more, some don’t accept transfers from existing Isas.
Currently, the top-paying instant access account in the UK is the Coventry Building Society Branch Instant Isa, which pays 2% a year (see the table below for a full list). However, you can only open the account at one of the building society’s branches.
If you’re not near a Coventry branch, you could go for the First Direct cash Isa, which pays 1.69% as long as you have a £10,000 balance. You’ll earn 1.5% if you have a balance of between £5,000 and £10,000.
If you’re prepared to lock your money away for a year or more you can earn higher rates, but the returns are still pretty poor. The top-paying account is the Virgin Money fixed-rate cash e-Isa (issue 85), which pays 3%. However, this is a five-year bond and you’ll have to pay a penalty if you want to withdraw your money early.
We’d also question the wisdom of locking up your savings for this length of time, given that the Bank of England is now at least talking about raising interest rates at some point – we’d be more inclined to go for a shorter period, or instant access.
Remember that you can also now hold cash in your stocks and shares Isa – so if you have money earmarked to invest, but are waiting for the right opportunity, you can put it there.
The only irritating thing is that it’ll earn even less interest while sitting on your investment platform – so if you have cash savings that you don’t plan to invest (an emergency savings pot, for example), then you’re better using a dedicated cash Isa.
Investing using your Nisa
When it comes to investing, you can now put an even wider range of assets into your Isa wrapper. These include individual shares (including many Aim-listed stocks, previously seen as being too risky); investment funds such as open-ended investment companies (OEICs), investment trusts and exchange-traded funds (ETFs); and corporate bonds and government bonds (including those with less than five years to go until maturity, which is a change from the previous regime).
From next year, you’ll probably be able to put certain peer-to-peer (P2P) investments in your Isa too. These are investments where you lend to other individuals or businesses via the web. The best-known P2P websites are Zopa, RateSetter and Funding Circle.
Setting up an investment Isa is a two-step process. First, you have to choose your Isa provider or ‘platform’. Then choose the investments that you want to hold in your Isa. Which platform is best? There’s no simple answer. It depends on how much you want to invest, and what you want to invest in.
So, before you choose a platform, you should have an idea of what you want to buy – you can then check if it offers the investments you want, and how much it’ll charge you to invest in them. I’ve looked at some of the most popular options below, but there’s a more extensive comparison table here.
Hargreaves Lansdown: this is probably the best-known investment platform, but don’t assume it’s the best option for you. Hargreaves scores well on reliability and customer service, but some of its rivals are cheaper.
It charges a 0.45% platform fee on your total investments up to £250,000, while the charge falls for larger sums. Dealing in funds is free and there’s an £11.95 charge for most trades in shares or investment trusts (less if you trade frequently).
Hargreaves has negotiated reduced charges on some investment funds – while most unit trusts now charge 0.75% a year, some only charge 0.66% or 0.54% on the Hargreaves platform – so if you value customer service and a big chunk of your portfolio is in some of the larger funds where Hargreaves has negotiated a discount, this could be the option for you.
Alliance Trust Savings: this platform is attractive to those with larger sums because it doesn’t levy a percentage charge, just a flat platform fee of £75 a year. You’ll have to pay a £12.50 dealing charge to buy individual shares and investment trusts.
Charles Stanley Direct: this platform only charges 0.25% for fund holdings, falling to 0.15% above £500,000. You won’t have to pay any platform fee on share and investment trust holdings if you make at least six trades in a six-month period. The dealing charge for shares and investment trusts is £10 a time. This is a good all-round platform.
Alternatively, if you plan to deal in a lot of individual shares, and you think you’re going to trade a lot, you should probably focus on the dealing charges. The cheapest players include iWeb on £5 a trade; SVS Securities at £5.75 a trade; and X-O at £5.95 a trade.
However, you can’t invest in OEICs on any of these sites, so they are very much aimed at individual stock investors. Also, if you trade often enough for dealing costs to be a big consideration, take a look at your strategy.
Over-trading is the ruin of many an investor and you may find that your profits do not justify the risks you are taking, or the costs you are racking up.
What to invest in
As Merryn Somerset Webb notes, there aren’t many bargain investments around right now. None of the major stock markets look cheap, and the US market in particular is on the pricey side.
Meanwhile, bond yields are very low by historical standards, and could suffer badly if interest rates or inflation start to rise.
This doesn’t mean you should keep all your money in cash – it’s very tricky if not impossible to time the market, and you could be waiting for a long time for opportunities to arise.
But it is a good reason to avoid the most expensive markets, and also to ‘drip-feed’ – in other words, invest a regular monthly or quarterly amount rather than a big lump sum. Then, if markets do have a setback, you’ll be able to buy some shares when they’re cheaper.
The other critical point is to watch your costs. You can’t be sure of many things in investing, but one thing you can be sure of is this: the more of your money that goes on paying fund fees and costs, the less there will be for you when you come to take your pot.
The cheapest funds (typically charging less than 0.5% a year, sometimes much less) are passive funds, which just track a particular stock market or asset price.
For example, a FTSE All-Share tracker fund would aim to deliver the same performance as the All-Share – if the index goes up by 10%, the passive fund should do roughly the same (a bit less after costs).
Most passive funds are either conventional OEICs – the sort of funds you’re familiar with from billboard advertisements – or ETFs. ETFs trade on the stock exchange, so you will incur dealing costs when you buy them, depending on the platform you use.
If you want to keep things really simple, you could just invest in a passive fund that tracks the FTSE All-Share index. This comprises the largest firms on the London Stock Exchange – more than 600 of them.
Your best options here are Fidelity Index UK fund, which charges just 0.07% a year if you invest via the Fidelity platform. (It charges a still very reasonable 0.09% on other platforms.) The Vanguard UK index fund is another cheap option, charging 0.15%.
However, I don’t think you should limit yourself to the FTSE All-share. Although it contains firms that operate all over the world, and it’s not too overpriced, you should diversify further and invest in some firms that are listed on other countries’ stock markets.
A simple way to do this is to invest in a tracker that buys shares in all of the world’s leading stockmarkets. You could go for the Fidelity Index World that charges 0.18% on the Fidelity platform and 0.2% elsewhere.
Or if you’d rather go for an ETF, the iShares Core MSCI World UCITS ETF (LSE: IWDA) is also very cheap at 0.2% a year. I also like the Vanguard Developed World ex-UK Equity Index fund, which tracks all the leading stockmarkets, excluding London. It charges 0.25% a year.
That’s two passive funds – one for the UK, and one for the world – and you could leave it at that. You’re not going to shoot the lights out, but nor are you going to see your money swallowed up in fees or poor performance by an active manager.
However, if you’re looking to add a little spice to your passive portfolio, we think Japan is one of the more attractive global markets right now. So much money is being printed there that at least some of that extra cash will probably feed through to higher share prices, and the government is determined to shake the economy up.
So, if you want to boost your exposure to Japan, you could go for the Vanguard Japan Stocks Index fund, which charges 0.3% a year.
What about active funds?
A good active manager can be worth paying for. The tricky thing is finding one – which is why we like investment trusts. Charges for these listed funds tend to be lower than for their unlisted OEIC counterparts.
History also suggests that investment trusts regularly outperform both passive funds and OEICs in the same sectors. I’ve highlighted a few such trusts that I think could do well. I’ve mostly focused on those that invest in areas where passive funds may not be the best option, such as emerging markets and smaller stocks.
These sectors have fewer number-crunchers analysing them, and so (in theory) there should be more opportunities for good fund managers to pick some winners.
RCM Technology (LSE: RTT): This well-known tech trust owns shares in the best-known tech stocks, such as Apple, but is also looking out for smaller, lesser-known shares.
It’s up 138% in the last five years and is trading on a 5% discount. In other words, the share price for the trust is actually lower than the value of the assets it owns – there’s a 5% gap between the two.
Henderson Smaller Companies (LSE: HSL): This is a solid fund that has grown 66% over the last three years. By investing in smaller firms, you’re hoping to buy shares in the giants of the future, which is a strategy that has historically beaten the wider market. This trust currently trades on a 15% discount.
Templeton Emerging Markets (LSE: TEM): I think most investors should have some exposure to emerging markets, such as China (one of the few genuinely cheap-looking markets around just now) and India.
The only exceptions are those who really don’t like much risk or who will need all their money for another purpose in the relatively near future. This is the best emerging-markets investment trust –it’s been around for a long time and is the top-performing trust in its sector. It’s also on a 9% discount.
Jupiter European Opportunities (LSE: JEO): Along with Japan, we think Europe is one of the more attractive markets in the world. The eurozone crisis is over (for now), money-printing is on the way, and there are signs of growth in several former basket-case economies. JEO is a great way to play this story as it’s the top-performing Europe investment trust over the last three and five years.
Baillie Gifford Japan (LSE: BGFD): If you’d like to invest in Japan via an actively run fund, this one is worth a look. The manager, Sarah Whitley, has a great track record. (For full disclosure: Merryn Somerset Webb, MoneyWeek editor-in-chief, sits on the board of another of Baillie Gifford’s Japan trusts, the Baillie Gifford Shin Nippon trust.)
MoneyWeek also runs a portfolio consisting of six investment trusts, which we give updates on twice a year – we’ll be updating on its performance in the next month or so.
| The current top cash Isas | |||
|---|---|---|---|
| Name | Time period | Interest rate | Notes |
| Virgin Money fixed-rate cash e-Isa (issue 85) | 5-year fixed-rate bond | 3% | Accepts transfers from other Isas. Online with similar branch account. |
| Aldermore 3-year fixed-rate cash Isa | 3-year fixed-rate bond | 2.25% | Accepts transfers. Online, phone and post. |
| Virgin Money fixed-rate cash e-Isa (issue 81) | 3-year fixed-rate bond | 2.25% | Accepts transfers. Online and branch. |
| Coventry BS Branch Instant Isa | Instant access | 2% | Branch only. |
| Virgin Money fixed-rate cash e-Isa (issue 84) | 1-year fixed-rate bond | 1.76% | Accepts transfers. Online and branch. |
| First Direct Cash Isa | Instant access | 1.69% | £10,000 minimum balance. Accepts transfers. Online, phone and post. |
| Cheshire BS Easy Saver Isa (Issue 5) | Instant access | 1.6% | Branch based. No transfers. |
| BM Savings Isa Extra | Instant access | 1.55% | Accepts transfers. Post. Includes 1.05% 12-month bonus. |
| Nationwide Instant I Saver; Virgin Money Easy Access Cash E-Isa (Issue 9); GE Saver Cash Isa (Issue 3) all offer an instant access Isa at 1.5% and accept transfers. | |||
Nisas versus pensions
Isas aren’t the only way to avoid tax on your investments. The other big tax-efficient wrapper is a pension. So which is best? It depends on what you’re looking for. For us, the big benefit of Isas is their flexibility.
You can take your money out whenever you want, but still benefit from an attractive tax break.
While some of the restrictions on pensions are being relaxed, following the most recent budget, you still can’t withdraw any money from them until you are at least 55.
What’s more, the tax relief you get from an Isa is broadly similar to what you’ll get on a pension. With a pension, you get the tax relief when you pay the money in (so as a basic-rate taxpayer, if you put 80p in, it gets topped up to £1 by the government).
But when you then withdraw money from your pension, your money is liable for income tax. With an Isa, you invest taxed income (so you don’t get any top up), but you don’t have to pay any further tax when you withdraw your cash.
That said, a pension does carry one significant tax advantage, which is that you can withdraw up to 25% of your pot as a tax-free lump sum. There’s no equivalent saving on an Isa pot. What’s more, if you’re a higher-rate taxpayer while you are working, but expect to be a basic-rate taxpayer in retirement, pensions can prove a more attractive option.
That’s because you can get 40% tax relief (or even more if you’re on the highest rate of tax) when you pay into the pension, and only pay 20% income tax when the money comes out.
The other point to note is that many employers will match your contributions to a pension pot.
If you have the opportunity to secure contributions from an employer, I’d urge you to make contributions yourself. But beyond that, my view is that the greater flexibility and simplicity of Isas makes them the better overall bet for most people’s savings.
Transfer warning
You may be tempted to move your existing Isas to another provider, and you should if you can get a better deal elsewhere. But just be careful about how you do it. Don’t just withdraw the money yourself, then try and invest it elsewhere.
Once you have withdrawn money from an Isa, its tax-exempt status is lost, and you can only pay the money back into another Isa if you haven’t already used up your allowance for the year. To avoid this happening, you have to ‘transfer’ your Isa.
Tell your new Isa provider that you want to make the transfer, and they should ensure that everything goes smoothly and you don’t lose your Isa protection in the process. Just bear in mind that the transfer process can take a while – as long as a month in some cases – and you will lose interest during that period.