This piece first appeared in Reader's Digest in July 2000
The text here may not be identical to the published text
Chancellor Gordon Brown gave a boost to tax-free savings this year when he said in his Budget that we could all put up to £7000 into an individual savings account (ISA) in 2000/01 – the same as in 1999/2000. That reversed a previous decision to cut the amount back to £5000. So should we take him up on his offer?
He might have done more to encourage tax-free savings if he had simplified the rules. But they stay exactly the same. So in 2000/01 you can
·Invest up to £7000 through one investment provider in a mixture of shares, cash, and insurance
·Invest up to £3000 into a cash savings account and up to £3000 in shares and up to £1000 into an insurance policy, all through separate investment providers.
The first option is called a Maxi ISA. It has the advantage that you can be flexible about your investments – you can put all £7000 in shares if you want or up to £3000 in cash and the balance in shares. But it is inflexible about the insurance company or bank you invest with. The same institution has to deal with all your ISA investment. And the best place for your stock market investment may not be the best for your cash.
Maxi is right for you if you want most of your money in the stock market.
If you take the alternative route, each of the three investments – cash, shares, and insurance – is called a Mini ISA. It has flexibility in that you can choose a different bank or investor for each of the Mini ISAs. But it is less flexible about the mixture - you are limited to the maximum amount of £3000 in the stock market. Even if you put a few hundred pounds into a cash ISA you are on the Mini ISA road and you can only invest up to £3000 in the stock market.
Go the Mini route if you want more control and want to choose your cash ISA carefully.
The other thing the Government did to confuse us all, for our own good, was to introduce a voluntary standard for ISA products. Called the CAT standard, it fixes the maximum Charges, keeps down the minimum amounts you can invest making Access easier, and sets out certain fair Terms which must be part of the contract. That sounds good. But most ISAs do not conform to these rules. And even those that do are not necessarily the best ISAs to go for – others may have better investment returns.
A cash ISA is simply a savings account where the interest is paid tax-free. So it is good news for taxpayers, especially those who pay 40% tax. Cash ISAs are very flexible – you can put money in and out of them during the year. The only restriction is that you cannot put more than the maximum in during the year – even if you have taken some out. So if you put in the maximum £3000, although you can withdraw money you cannot make further deposits in that tax year.
Many of the rates on offer are better than the very best you can get on instant access accounts that are not ISAs. For example you can get 7.75% a year with Coventry Building Society through a branch, 7.25% with Smile (the internet-only Co-operative Bank), and 7.15% with Simply Postal (though that is not CAT marked). These are all well over 1% more than you could get in a normal savings account and the interest is tax-free!
The heart of any investment strategy must be shares. Overall a balanced share investment will always rise in the long-term (or at least it always has so far). If you want to put more than £3000 into a shares ISA then you have to go for a Maxi ISA. But remember that if you have already invested in a separate, cash Mini ISA this tax year, then the maximum you can put into a stock market investment is £3000.
There are all sorts of ways of putting ISA money into the stock market. You can put shares in unit trusts, open-ended investment companies (OEICs), or some investment trusts into an ISA. You can even pick the shares yourself – though you have to do this through a provider such as a stockbroker. The money does not have to be invested in UK companies – they can be anywhere in the world. However, CAT-marked ISAs have to be at least 50% invested in the UK.
There is no capital gains tax to pay on the rising value of shares in an ISA – though in practice that does not mean much as the first £7200 of gains this year are tax-free anyway. There is no income tax to pay on the dividends – even by higher rate taxpayers. But the fund will only be able to reclaim a 10% tax credit on them, making the advantage of holding them in an ISA smaller than in the past.
Charges can be high – you may be charged a fee when you invest which is a percentage, maybe as high as 6%, taken straight off your money, an annual fee of 1.5% or more off the value of your investment, and when shares are sold the price given is less than the price charged when they are bought – the notorious ‘spread’. CAT marked funds are only allowed one of these charges – an annual management fee of up to 1% taken off your money. So there will be no upfront fee and no spread – shares are bought and sold at the same price. You can find CAT marked products in both ‘trackers’ that passively follow the stock market, and ‘managed’ funds which are run by a manager. But remember to look at past performance as well – that can outweigh high charges.
Do not put insurance products into an ISA. There is no real advantage and there are dangers in mixing insurance with investment. Most people have enough insurance anyway.
If you want to invest and you pay tax, put as much as you can afford into an ISA. Cash ISAs are particularly good value for those savings that you expect to keep for a year – but there is no penalty if you take them out. Stock market ISAs have less attraction – unless you are very wealthy the tax concessions are much more modest. If you are starting off in stock market investments, start with a CAT-marked fund that tracks the stock market. If you want to be more adventurous go for a managed fund or something invested in other parts of the world. Check performance and charges. Low charges won’t make up for bad investment performance – but it takes very good performance to make up for high charges.
Most important, if you have money to invest and you think an ISA is for you, invest it now. No-one can predict if the stock market or your shares will go down or up. But in the long term the market will rise. And a cash ISA will start earning interest from day one. So the best time to invest is always now. Do not put it off until the end of the tax year – you could miss out on a whole year’s growth.