The ISA has long been a household name, with savers and investors utilising their generous, tax-free annual ISA allowance to build cash savings, invest into equities and hold peer-to-peer loans and debt-based securities.
And since the introduction of the ISA in 1999, the annual ISA allowance has been on the increase. After starting out at just £7,000, it now stands at £20,000 for the 2021/22 tax year – allowing more and more opportunities to take advantage of the income and capital gains tax-free status of the ISA to maximise potential returns.
However, the average amount contributed to an ISA is far below the £20,000 limit. Whilst the number of Adult ISA accounts subscribed to in 2019/20 was up on 2018/19 at 13 million compared to 11.2 million, the average subscription amount had decreased 5% to £5,740.
It’s understandable that one reason for this could be that, for a lot of retail investors, contributing £20,000 to an ISA each year isn’t a possibility. And it’s important to keep in mind that whether it’s £1,000 or £10,000, saving or investing with an ISA is a crucial, tax-efficient consideration.
But for experienced investors with the means to subscribe the maximum but don’t, it’s vital to understand the importance and potential of the ISA – as for the vast majority of experienced investors, contributing the full ISA allowance will be one of the most tax efficient components of the wider portfolio.
Low interest rates have some savers doubting the impact of an ISA
Cash ISA interest rates have been low for some time, similar to the interest rates offered on standard savings accounts, too. But over the past 18 months, these have hit rock-bottom.
A cut to the Bank of England’s base rate in March 2020 – in response to the Coronavirus crisis – sent interest rates plummeting as it reached a record low of 0.1%, meaning savers could be seeing their lowest returns to date.
With the best instant-access Cash ISA rate on the market at present sitting at 0.54%, in real terms, the £50 billion subscribed to Cash ISAs by savers in 2019/20 could in fact be decreasing in value as rates fail to keep pace with inflation.
And with the Consumer Price Index showing inflation at 2.1% for the 12 months to May 2021 – but with no change to the Bank of England base rate – it puts the value of cash savings in a perilous position.
Clearly not an attractive proposition for savers at any level, with the outlook on the Cash ISA looking bleak, it’s unsurprising that some are choosing to put smaller amounts of their cash savings into the product.
Yet whilst the Cash ISA still has an important role to play for cautious savers and experienced investors alike - instant-access to at least some level of cash reserve will always be a necessity - it has to be remembered that although the Cash ISA is synonymous with the broader ‘ISA’ phrase, it is no longer the only product that can benefit from the ISA wrapper.
And what’s more, the other ISA products will generally be targeting rates of return that not only exceed that of the Cash ISA, but far outstrip any level of inflation.
An ISA product for everyone
For experienced investors and those with a larger sum to contribute to an ISA, on the assumption financial returns are the primary goal, it comes as no surprise that the Cash ISA isn’t the best place for their funds. But that doesn’t mean their ISA allowance should go to waste.
The Adult ISA market boasts the Stocks and Shares ISA, Innovative Finance ISA (IFISA) and Lifetime ISA under its banner. Of these, the Stocks and Shares ISA and IFISA in particular could be a much more attractive consideration for those with the appropriate appetite for risk.
Unsurprisingly, the Stocks and Shares ISA is often the first of the additional products to come to mind for investors - it allows for exposure to the global markets in a vastly similar way to the experience received by investing directly. The potential for far greater returns than 0.5% with the Cash ISA is undoubtedly there, but due to the volatile nature of the markets – highlighted in recent months as they suffered severe fluctuations due to the Coronavirus pandemic – the Stocks and Shares ISA may not be the most appropriate choice for all investors.
This is where the IFISA comes in. Introduced in April 2016, with an IFISA investors can utilise their £20,000 ISA allowance to invest into alternative assets such as property bonds, targeting tax-free potential returns of between 4% and 8%.
Along with opportunities to invest for impact – for example, via backing environmental projects or supporting small and medium-sized housebuilders to tackle the UK’s housing shortage – the popularity of the IFISA has increased notably since its launch, with IFISA investment exceeding £1 billion in 2019/20.
With investors experiencing considerably less volatility with the IFISA when compared to their Stocks and Shares counterpart (particularly for property bonds where there will generally be a fixed term and interest rate) and targeting interest rates several points above even the best Cash ISA, it can prove to be a worthwhile addition to an experienced investor’s ISA portfolio.
Making the most of the annual ISA allowance
Over 20 years after it was established, the ISA remains one of the most generous tax incentives available to savers and investors in the UK. Because of this, for experienced investors who are able to do so, taking full advantage of the ISA allowance is an important, tax-efficient consideration.
Once synonymous with the Cash ISA, the ISA is now so much more. Though the low interest rates on a Cash ISA can look unattractive to experienced investors wanting to maximise potential returns, the wider ISA market – which includes the Stocks and Shares ISA and IFISA – not only offer the potential to target higher rates of returns, but also to achieve a large amount of portfolio diversification, all within the ISA wrapper.