Ignore Isas at your financial risk, says JEFF PRESTRIDGE
We live in financially challenging times. Bills and taxes continue to rise, while higher interest rates are a double-edged sword, offering financial comfort to savers but unease to homeowners with a mortgage.
At such times, it may seem appropriate to put long-term savings aside. In fact, 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 are now ready to be set up and accessed when needed – whether it’s to pay for the vacation of a lifetime, a new car, or to top up our retirement income
Fortunately, we have a government that encourages us to save while the nation’s finances and our own remain tight. It does this by giving us generous tax breaks on money we scoop into our company or personal pension plans. It also allows us to build wealth in an individual savings account, a kind of tax-free shell.
While most of us are automatically enrolled in a retirement plan by our employer, Isas is not.
Nobody will push you into an Isa. They’re for you to set up, finance, and access at some point in the future when you need them, whether it’s to pay for the vacation 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 very underrated. Perhaps it’s because we’ve always been told that pensions are the bee’s knees – a result of the fact that we receive generous tax breaks on our pension contributions, as well as top-up payments from our employers.
But ignore Isas at your financial peril. Not only are they a perfect savings complement to retirement, but they also offer a simplicity that retirements don’t possess.
In short, see an Isa as your tax-free fortress to which no one but you holds the keys. Whatever you put in that financial fixture — cash, stocks, or mutual funds — the IRS can’t keep up.
The result is that all savings and investment income generated within an Isa is tax free. In addition, any capital gains from capital investments are tax-free.
Don’t be intimidated into doing something beyond your normal tolerance for risk – like when friends boast about the rising value of their Isa over a pint in the pub
So when it comes to Isas, forget about upcoming cuts in annual tax-free dividend and capital gains allowances. And to add icing to the cake, your withdrawal is not subject to taxation (unlike an annuity, where most withdrawals are taxable) or age requirements. Withdrawals are tax-free at any given time. All pretty convincing, I would say.
So use an Isa to build tax-free wealth and financial independence later in life. Adults can save a maximum of £20,000 each tax year from April 6th to April 5th of the next year, while children can save £9,000.
These are generous annual allowances that I beg of you even if, like me, you have no way of hiding the maximum allowable.
In terms of the Isa strategy you use, it’s really up to you. The key is to understand the basics of your Isa and the risk to the underlying capital.
Don’t be intimidated into doing something beyond your normal risk tolerance, such as peer pressure when friends boast about the rising value of their Isa over a pint in the pub. Do your own Isa thing.
With the Bank of England’s base rate standing at 4.25 per cent, compared to just 0.1 per cent in early December 2021, a cash-based Isa now looks quite attractive if it comes with an attractive interest rate.
Some cash isas that provide instant access pay 3 percent interest or more, while fixed rate deals can be found above 4 percent.
Most of these top deals are offered by building societies and specialized online savings banks.
Keep an eye on the This is Money best buy savings rate charts for an up-to-date overview of the best interest rates.
Higher interest rates on cash savings held outside of an Isa mean more people have to pay tax on their savings income because their annual interest exceeds the tax-free personal savings allowance. This is currently £1,000 for the base rate and £500 for higher rate taxpayers. Converting some of that savings into tax-free Isa cash makes financial sense.
Long Game: Stocks & Shares Isas give you the opportunity to earn a mix of capital and income return over the long term
Stocks and shares of Isa should not be excluded
Although cash-based plans are the most popular type of Isa, stock and equity plans should not be ruled out.
In fact, you can mix and match them, putting a portion of your contributions into one cash-based plan and the rest into another Isa that allows you to invest in stocks, mutual funds, and listed investment trusts.
While the banking crisis in the US and parts of Europe has unsettled equity markets – and may continue to do so – Aktien & Aktien Isas offers you the opportunity to generate a mix of capital and income returns 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 Isa and the right DIY investment account
You can then invest when you want, how you want (e.g. in direct shares, mutual funds or a model portfolio designed by the platform) and according to your financial situation.
The only condition is that you stick to the annual limit of £20,000.
Investing instead of saving also makes sense as the foundation for a Junior Isa (Jisa) that parents can set up for their children. This is due to the long-term horizon involved – exits from a Jisa cannot be made before the age of 18.
However, the investment rules apply to Jisas in the same way as to stock and unit Isas. That means spreading investments across mutual funds — and making monthly contributions rather than occasional lump sums.
Some platform providers like Hargreaves Lansdown and Interactive Investor go out of their way to woo Jisa customers by slashing their fees to the bone. However, there is one final word of warning. If you’re concerned about using this tax year’s Isa stocks and shares or Jisa allowances, you can deposit some money first — and then invest it once you’ve figured out where it’s best to use it.
In a financial services industry not known for making things particularly easy for customers, Isas are about as straightforward an offering as you’re likely to find.
They’re a good financial habit that you should be enthusiastic about adopting.
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