An Introduction to ISAs
Research by financial website Credit Action suggests that, as a nation, we are just not doing enough to save. It claims, ‘Less than half (43%) of the population are planning for their financial future’ while ‘Over one in four (27%) have no savings at all.’ It’s a worrying fact that over the last decade in Britain we have become a nation of spenders rather than savers, and we’ve accrued a gigantic consumer debt mountain in a relatively short space of time. It now stands at a whopping £1.3 trillion.
The government took particular action to encourage people to save way back in 1999, when it introduced the independent savings account (ISA). This allowed people to have tax free savings up to a certain amount per year. However, the whole ISA scheme has been criticised for being overly confusing, and further stats from Credit Action back this up. The website states, ‘Around 15 per cent of 18 to 24- year-olds think an individual savings account (ISA) is an iPod accessory, and one in 10 reckon it's an energy drink.’
It seems quite worrying that so many young people are so estranged as to what the real meaning of an ISA really is. However, even if you visit the HMRC website, it might not become immediately clear exactly what an ISA is, or what it does. The good thing is that from 6th April 2008 the rules are changing to make it simpler.
An ISA investment allowance runs from 6th April to the following 5th April, and from April 6th 2008 the annual allowance will stand at £7,200. You will be able to save up to £3,600 of that in cash with a provider. You can save the remainder in stocks and shares with the same or a different provider. For a full list of new rules, including FAQs, take a look at the HMRC website.
Because you don’t have to pay tax on an ISA, they are a very efficient way to save. Using a stocks and shares ISA over the long term can also be very lucrative, because you will pay no capital gains tax. There are, however, a couple of drawbacks with the current system.
The first of these is that you can withdraw your funds from your ISA, but once you take money out your ISA investment allowance remains the same, so you might not be able to put money back in. This doesn’t give you the flexibility of many savings accounts. Recent research by Alliance and Leicester found that around half of ISA savers would like to be able to withdraw and top up (up to the maximum limit) without losing their tax-free benefits.
The second issue is that those with those with cash ISAs will be able to transfer their funds into their stocks and shares ISA, but not the other way round. This means that investors will not be able to switch their stocks and shares into cash during periods of market volatility. It seems to be a worrying element for many investors, as A & L’s research found that over half of ISA savers are concerned about their current stock market investments.
It’s natural for investors to be worried about stocks and shares in periods of market volatility. However, it’s got to be stressed that these options should only be taken out in the long term. Over the span of one year, stocks and shares have only beaten the performance of cash 50% of the time, but over 5 years this increases to 80%. Over 20 years, this increases to a very attractive 98% of the time. Saving a regular amount in stocks in shares per year over the long term, as ISAs allow, is an excellent way to save, especially when you take out the factor of capital gains tax.