What You Need to Know About Super ISAs

It has been dubbed Britain’s biggest saving plan and it has undergone some major changes recently. Approximately 24 million Britons, half the adult population, hold an Individual Saving Account (ISA), which is a class of retail investments arrangements available to those residents of the United Kingdom. The principal advantage of an ISA is that savers are exempt from income tax and capital gains tax on the investment returns, and no tax is payable on money withdrawn from the scheme either. Cash and a broad range of investments can be held within the plan. Moreover, there is no restriction on when or how much money can be withdrawn. Payments into the account are made from net income earned.

Chancellor George Osborne’s sweeping changes to ISA, which came into effect on July 1, now means that ISA savers can invest more, pay less tax and decide where they invest. So under the new ISA scheme, known as super ISAs, the annual amount savers can now invest within an Isa per year rises to £15,000 from July 1, which is nearly treble the cash ISA limit of £5,940. Perhaps another and more significant change to ISAs from the beginning of this month is that the previous restrictions that could be saved in cash ISA accounts as opposed to stock market investments has been abolished, thereby giving savers freedom to exit out of equities should they wish to do so.

Indeed, the new rule now implies that a saver can sell all their existing shares held in their ISA account and transfer part, or all of the proceeds into an ISA cash accounts with different providers. This means that nervous investors who require access to the funds in the immediate or short term future, for say a deposit on a property or retirement could then move all or part of their ISA savings out of shares into cash.

Assuming the saver has started a new cash ISA this tax year with a building society, then decides to invest some of the extra allowance into a stock market fund. Under the new rules they would be entitled to open one cash and one stock market ISA per year. Moreover, the saver would be free to choose any provider of stock market ISAs and could invest up to £15,000 within the two ISAs.

So what if savers have locked in fixed-rate cash ISAs with their banks, say early in the year, would they then still be able to top up the same account to the full £15,000 from July? Apparently, this may be possible bearing in mind that fixed rate accounts, guarantee a set rate of interest over the agreed period and that interest rates have not varied much throughout the year, so many providers are allowing top ups at the agreed same rate.

But how will funds be transferred from a share ISA, which is managed by an investment house, to a cash ISA run by a different institution, such as a bank or building society. It’s very likely that the two separate institutions don’t share the same computer systems, have different rules and different administrative systems. This would mean that any transfer of funds from share ISAs to cash ISAs would probably have to be done manually. Currently savers can transfer cash ISAs from one building society or bank to another electronically, without much complications. Indeed, a transfer from one cash ISA to another takes on average eight days, which incidentally also happens to be the same time period required to transfer cash to shares.

However, the electronic transfer of funds from share ISAs to cash ISAs will not be possible in most cases and it doesn’t take much imagination to see that this could result in an administrative headache and delay for the saver. According to industry guidelines published just last week savers would have to wait up to a maximum of 26 working days (36 days in total) for their money to be moved from an investment ISA to a cash ISA. Additionally, during this delay in the transfer of funds the saver will not be entitled to any interest payments. Some industry experts believe that this week’s Super ISA launch is really a complete unknown, which could cause problems. If the volume of shares to cash switches is low then the system should be able to cope. Where the problem could arise is when savers are switching from shares to cash in masses, then things could get really clogged up, claimed an industry expert. Transfer requests sitting in mail bags for days on end and savers losing interest while their cheques are in the post and paperwork gone astray typifies the kind of problems that could arise. Nevertheless, transferring one cash ISA to another should still remain relatively straightforward.

ISA holders are advised to select the cash ISA that suites them best and to shop around for the highest interest rates. Should you decide to sell your investment ISAs, don’t leave the funds too long in your ISA investment account, as it will earn you little or no interest. The best payer of fixed rates at the moment is Virgin Money, which accepts transfers and new money. Savers also need to bear in mind that while cash ISAs don’t charge you penalties for transfers, investment ISAs do. In some case you might be charged up to £175 to leave and move to a rival firm.

However, despite some potential hiccups arising from the super ISA the saving plan is still being heralded by many as a major boost for savers, giving them more freedom to decide for themselves how and where to invest. Admittedly, the bank rates are so low that the cash brakes on deposits in ISA maybe worth next to nothing, thereby cancelling out the benefit of the higher allowance. So Super ISA may be just another super political sound bite. But what remains to be seen is whether savers will stampede out of equities into cash or vice versa. What happen here could then determine the future direction of equity markets.

Being smart with your cash

In today’s environment of low interest rates it is becoming increasingly difficult for savers to find a home for their cash which produces a meaningful rate of return. Accounts traditionally regarded as “risk free” are increasingly producing diminishing rates of return especially once inflation is factored in. Even when one has been lucky enough to identify an account offering higher rates than are typical, these often disappear before investors are able to take advantage of them, as banks limit their availability. Often the higher interest bearing accounts that are available require savers to tie their money up for a period of time after which the account defaults to a significantly lower rate. Banks rely upon the inertia of savers to move their account to take advantage of better offers once this fixed term has expired. This inertia can be due to a number of factors: either they have forgotten when the fixed period ends, they are too lazy or busy to look for another account paying a higher rate, or in some cases they have forgotten about the account.  According to recent research by Which?, savers are losing £4.3 billion a year by not moving their money from extremely low interest bearing accounts known as “zombie” accounts which used to pay good interest rates but now pay next to nothing. Apparently 8 out of 10 easy access savings accounts pay very low rates of interest and 4 out of 10 pay 0.1% or less.

Being smart with your cash takes effort. If you want your money to work for you then you have to be prepared to put the work in too. For savers with access to the internet there are many useful websites that can help in the search for the best rates available such as Moneyfacts.co.uk, GoCompare.com, MoneySupermarket.com, ThisIsMoney.Co.UK and CompareTheMarket.Com. For those who do not have access to the internet many Sunday Newspapers have a Money Section which lists the best rates available for savers, however this is not as comprehensive as the internet listings. Beware as some accounts provided by the same institution seem to have similar names but pay very different rates.

Four important considerations when choosing a home for savings are:

What is your tax rate?

How much are you planning to invest?

For how long do you plan to invest the money?

Do you intend to reinvest or withdraw the income?

Not all accounts are straightforward. Some require a monthly fee while others require savers to keep a minimum balance in the account. Additionally there could be rewards associated with some of the accounts which entitle savers to cashback provided certain criteria are met. This can mean that an account which levies a monthly charge could actually work out more beneficial provided the reward criteria are met! The websites allow comparison of the various accounts that are on offer and usually have a link to the providers’ own website from where more information can be found and allow online application.

If savers are not expecting to access their funds and would like to shelter the interest from tax, particularly useful for higher rate tax payers, then investing the money into a Cash ISA is a useful option. Interest rates tend to be a little higher on money that is tied up. Higher rate tax payers who have already utilised their ISA allowance could always put additional savings in the name of their partner if they are lower rate tax payers.

Savers need to take into account accessibility and ensure that the funds are not tied up for a fixed period if the money is likely to be needed within that time frame. Some accounts have a withdrawal limit so make sure that any potential calls on the savings fall within that amount.

It is important to ensure that the same type of interest rates are being compared. There are two versions that banks quote – the Annual Equivalent Rate (AER) which takes into account compounded interest over the year and the Gross rate which is the flat amount paid over the year. Both rates are usually quoted before tax. Some accounts will pay a bonus rate after a certain period.

There are other investments which are considered to be “safe” such as Premium Bonds and National Savings Income Bonds. There is no set term with Premium Bonds and sums between £100 and £30,000 can be invested. Instead of paying interest there is a prize draw every month with a £1 million jackpot and other cash prizes. All prizes are tax free and the funds can be withdrawn at any time with no notice and no penalty. The drawback however is that unless you are a winner in the draw your money is at the risk of erosion from inflation over time. Income Bonds allow investment from £500 to £1 million per person and again have no notice or penalty attached to them. The rates are variable and are currently set at 1.25% gross/1.26% AER. Further details of both accounts are available from the Post Office or online at nsandi.com.

One of the most powerful tools when investing is compounding. Re-investing the interest that is paid means that savings will grow quicker because you are not only earning interest on the original savings but also on the interest that is paid. For example: Assuming £100 per month is invested for 30 years at an annual interest rate of 3% this will produce interest amounting to £36 per year. At the end of the 30 years £1,080 will have been withdrawn and the amount saved will amount to £36,000.

However, if the interest is not withdrawn, then the amount that interest is paid on, rises each year. So instead of £36 interest being paid out in year one, this amount is added to the balance increasing it to £1,236. In year two, 3% interest is paid on this amount totalling £37.08, which is added to the balance, and in year three 3%  is paid on £1,273.08 and so on, until after thirty years of saving the balance reaches £58,273.68. This is 61.87% more than if you had taken the interest each year. Compounding can give a huge boost to savings from a small base.

Always remember not to invest more than £85,000 per person in any one financial institution as this is the limit for compensation under the FSCS should the bank collapse.

Darren Winters