Every investor should have one of these – and now they’ve just got better
From 1 July, the tax-free individual savings account gets a major overhaul. John Stepek explains what the changes are, and how they will affect you.
From tomorrow 1 July the individual savings account (Isa) that we know and love gets a major makeover.
Now it's going to be the New Isa' (or Nisa).
Yes, we'd agree that the name lacks a certain amount of imagination. But it's unequivocally good news for investors. Which is why you should make sure you know what's going on.
Here's what you need to know.
A short summary of the big changes to the Isa
Currently, you can put up to £11,880 a year into an Isa, with up to half of that amount in cash. An Isa is a wrapper' that protects your investments from tax. You can also get at your money any time you want (barring any conditions attached to specific investments).
Everyone should have one. The benefits might not be immediately apparent for basic-rate taxpayers. But over the long run, you could save a fortune in capital gains tax. And chances are, you're more likely than you think to end up on a higher-rate tax band at some point.
So that's the short rundown of the reasons to have an Isa. And the new Isa is even better.
From 1 July, the annual Isa allowance is going up to £15,000. And you can split that between cash and investments in any way you like. So the lot can be in cash if you want. You can also switch between cash and investments as you see fit, whereas this was restricted before.
In short, the new Isa is a much more flexible version of the old Isa. My colleague Ed will be giving the full rundown on the changes in MoneyWeek magazine this week. If you're not already a subscriber get your first four issues free here.
The one big advantage Isas have over pensions
Of course, there's another very popular tax-efficient wrapper' the pension. Pensions are similar to Isas in that they allow your savings to grow unencumbered by tax. And one specific aspect of pensions the chance to take a 25% lump sum entirely tax-free gives them a big tax advantage over Isas.
However, for me, one under-appreciated advantage of Isas is that they carry less political risk than pensions. Isas are transparent, easily accessible, and popular. Any government that meddles with them runs the risk of damaging its electoral chances. So no guarantees, of course but you'd expect the rules governing them to remain relatively stable in the coming years.
Pensions on the other hand, are a big, fat tempting target. Lots of people in Britain have a vague feeling that pensions are a rip-off anyway (partly down to myriad mis-selling scandals in the industry). The topic is boring I know from experience that the very word pension' in an article is a real turn-off for many people. And the people who benefit most from the tax breaks are the wealthy.
Of course, the wealthy benefit the most from pensions because that's the way that pensions were set up in the first place. The tax break is there to encourage you to save. There's no tax-dodging, or even a stretching of the rules, going on here. But governments have a great habit of feeling intensely comfortable with something one day, then changing their mind with the political weather the next.
So if you're a politician looking for some spare change, and you've got a choice between raiding the savings pot marked pension' or the one marked Isa', which are you going to go for? Hands-down, it's got to be pensions.
Now, the current government has done some pretty positive things on the pension front. You can read more about these in this free guide that covers the huge changes chancellor George Obsorne made in his last Budget.
But at the same time, the current government has also reduced the overall amount you can put into a pension over your lifetime. And it keeps vaguely threatening to either cap the tax-free lump sum, or impose some limits on higher-rate tax relief. Just think about what a government that was less well-disposed towards investors might try to do.
What to put in your bigger, bolder Isa
My point is not necessarily to avoid pensions altogether. If your employer contributes to your pension then there's rarely a good reason to turn that down. And pensions do still enjoy generous tax breaks, particularly if you are currently a higher-rate taxpayer who will be on a lower band when they retire.
I'm just pointing out that Isas beat pensions in terms of reliability and predictability. And that has more value than most people realise. So I think that everyone should have at least some of their savings pot in their Isa.
So now for the tricky part: given that markets are hardly at bargain levels just now, what should you put in your Nisa? Ed will be looking at this in more detail in the next issue of MoneyWeek too.
But if you're interested in a very specific, easy-to-follow guide on how to build a long-term savings pot, you should take a look at my colleague Phil's Lifetime Wealth newsletter. Phil has built a complete, diversified portfolio using just 12 easy-to-buy funds. Everyone from those just starting out to the experienced investor would do well to follow Phil's principles. Find out more about it here.
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