Like most things, the ISA market has faced confusing and uncertain times since the seriousness of Coronavirus became apparent in 2020. Already low interest rates on the Cash ISA hit rock-bottom after the Bank of England cut their base rate to 0.1%, and the Stocks and Shares ISA was hit with severe fluctuations as the stock market reacted to the worldwide crisis.
But even pre-pandemic, more and more savers and investors were shunning ISAs, as subscriptions to a Cash ISA had been on a continuous decline until a rise in 2018/19, whilst Stocks and Shares ISA subscriptions were down 15% in the same year.
On top of this, most are not taking full advantage of the annual ISA allowance, which has been £20,000 since 2017/18. The average amount subscribed to a Cash ISA in 2018/19 was £5,187, with a higher amount of £9,331 the average for a Stocks and Shares ISA – both well under the threshold.
However, though the Cash ISA and Stocks and Shares ISA are the most well-known, there are other ISA options available which are less volatile in nature and offer higher potential returns. So whilst some ISA products may not be worth it when looking to generate considerable returns, others could be an important addition to an investors portfolio.
Higher risks equate to higher potential returns
Both the Stocks and Shares ISA and Innovative Finance ISA (IFISA) have a risk profile of medium–high, whilst the Cash ISA has a low risk profile. And the Stocks and Shares ISA and IFISA both offer potential returns in excess of 4% (and as high as 8% when property bonds are held in an IFISA), whilst the top Cash ISA rate at present is sitting at just 1.1%.
This is because with higher risks, comes higher target returns.
Contributing £20,000 to a Cash ISA with an interest rate of 1% would see a return of just £20,812 over a four year period. On the other hand, over the same term, £20,000 in an IFISA with an interest rate of 7.75% has the potential to generate a return of £25,812.
However, it’s important to remember that a Cash ISA and an IFISA can not be compared like-for-like. An IFISA is an investment product, meaning there is no guarantee of returns and capital is at risk.
For a cautious saver who would feel more comfortable with guaranteed returns and Financial Services Compensation Scheme (FSCS) protection in the event of provider failure, a Cash ISA is the most appropriate option.
And though the record-low rates on offer can seem unattractive, holding cash savings is an important part of a diversified portfolio, and doing so in a Cash ISA means you benefit from an ISA’s main incentive – tax-free returns.
But for experienced investors willing and able to take more risks, the IFISA has the potential to be far more lucrative, with returns also free from income and capital gains tax.
A tax-efficient method of saving and investing
As mentioned, the core benefit of an ISA is the tax-free returns. These make the ISA wrapper one of the most generous tax incentives available for both savers and investors in the UK.
Although the personal savings allowance allows basic-rate taxpayers to earn up to £1,000 in interest tax-free, and higher-rate taxpayers up to £500, for those with larger sums of cash to save, a Cash ISA is the best option for eradicating what could be a susbstantial tax bill.
It’s not just the Cash ISA that is facing all time low interest rates. The highest rate available on a generic savings account – which would not render returns above the personal savings allowance tax-free – is 1.35% fixed-rate, or just 0.5% easy access.
Therefore the tax-free returns offered on a Cash ISA make it more than worth it for savers who will earn above the £1,000 and £500 thresholds, and for additional-rate taxpayers who do not benefit from the personal savings allowance.
And for experienced investors, the tax-efficient benefits of an IFISA are a crucial consideration for maximising returns.
Outside of the ISA tax wrapper, to earn the same returns as achievable at 7.75% per annum with an IFISA, the gross equivalent rate would be over 14% for those taxed at the additional-rate – an almost impossible rate of return to target within an IFISA, and one investors should be cautious of if found.
More than just financial returns
When looking at whether an ISA is worth it, it’s helpful to look beyond the financial returns.
It’s clear that one of the latest additions to the ISA market, the IFISA, has the potential to be a valuable addition to an investors portfolio. The product enables investors to hold alternative investments under the ISA banner for the first time, with tax-free target returns of up to 8% available.
But that’s not all an IFISA has to offer. With opportunities to hold property bonds, environmental projects, SME loans and consumer loans, the IFISA can be a key tool for making impact-driven investments.
From supporting small and medium-sized housebuilders in providing much-needed housing amidst a chronic shortage, through to helping British businesses progress and contribute towards the UK’s economic growth, the IFISA gives experienced investors the chance to maximise potential returns whilst also making a positive societal, environmental and economic impact.
Adding an ISA to your portfolio
For cautious savers through to experienced investors, an ISA should be a consideration. Which ISA is the most suitable and valuable will be dependent upon personal circumstances, and seeking independent advice before making a decision is critical.
But it’s simple – for those looking to reduce their tax bill, maximising returns in the process, an ISA could be more than worth it.
And for experienced investors with the appropriate appetite for risk, building a diversified portfolio by spreading the annual ISA allowance across ISA products is a tax-efficient means of serving different saving and investment goals and benefiting from each ISA’s individual advantages.