Do you know your ISA from your JISA or your LISA?
- 11 August 2020
- 10 minute read
There are now a number of tax efficient savings accounts from which to choose
Getting your head around the acronyms can be like looking at a plate of alphabetti spaghetti
In this article we aim to help you unravel the basics
In the past, deciding how to invest for the future in a tax-efficient way was simple: you could save into a pension or an Individual Savings Accounts (ISA). Or before 2000, the ISA’s predecessors the TESSA and the PEP.
But to encourage more people to save, governments have widened the range of ISAs to appeal to different types of investor. Each has its own features and conditions.
So what are the different types of ISA and how do you work out which version is right for you?
The traditional ISA
ISAs allow everyone over the age of 16 to save in a cash ISA, although you have to be 18 or over to hold a Stocks and Shares ISA. You can save or invest up to a set limit each tax year: this year it’s £20,000. Once saved or invested, any income or capital growth is free of tax both within the account and when you decide to take it out. What’s more, you don’t need to declare it on your tax returns.
Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.
When you open an ISA you can elect to hold either cash or investments. When ISAs were first devised, savers were evenly divided between the two options, but according to the most recent data from HMRC, and as reported in the FT in June 2020, just over 75% of new ISAs in the tax year 2018-19 were in cash.
Cash or investments?
Keeping some savings in cash and easily accessible makes sense. The amount you set aside will depend on the answer to two questions: what are your usual average monthly expenses? And how much do you want to set aside to be able to sleep well at night? Three month’s spending is a good rule of thumb but if you’re a worrier it’s down to what makes you comfortable.
Currently, interest rates are at record lows, so a cash nest egg risks being eroded by inflation. But if your time frame is longer, five years or more, then investigating what investments may suit you could be worthwhile.
Your goals, your timeframe, and your appetite for risk will all help you to decide what kind of investment to choose.
ISA or pension?
Why have an investment ISA instead of just putting all your surplus money into your pension? Good question. One obvious reason is that you can access your ISA money whenever you like (unless you’ve picked an account with a fixed investment term). Meanwhile, you’ll have to wait until you’re 55 to access your pension funds, rising to 57 in 2028 and potentially rising further in line with increases in the state pension age.
Pensions are a long-term investment. The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits, which isn’t guaranteed, and can go down as well as up. The benefits of your plan could fall below the amount(s) paid in.
One ISA advantage is that when you withdraw your money, you don’t pay any income or capital gains tax on it. Whereas when you withdraw money from your pension, the first 25% is free of tax but the remainder is taxed as income.
So, if you’re saving for your retirement, a combination of pension and ISA savings might be cleverly tax efficient.
JISAs: ISAs for juniors
The Junior ISA, or JISA, is designed to let a parent or guardian open up a tax-free savings account for children under the age of 18. It’s handy to know that when the junior saver turns 18 – their JISA will morph into a fully-fledged ISA.
This tax year a child can save up to £9,000. A parent or guardian can save this money for a child in addition to their own £20,000 annual ISA allowance. Once the JISA account is up and running, other adults can contribute towards it, too.
So grannies, grandpas, aunts and uncles can get involved. All adults might like to bear in mind that gifts of up to £3,000, or money that is from ‘surplus income’, have no inheritance tax implications.
To invest or not?
Once you’ve got the JISA account set up, the next big question is: cash or investments? Just like selecting what to put in your own ISA, think about how long it will be before your child might need to draw on the money. If the child is approaching the age where they might want to take the money out, maybe to offset university or travel expenses, then cash could be the better option. If they’re younger and you’ve got a longer time frame in mind, you could consider some investments. There’s no need to bet junior’s future on anything high risk or niche. Diversified funds balance the risk of investing by spreading investments across a range of asset classes, to reduce extreme highs and lows.
The value of investments and the income from them can fall as well as rise and the investor may not get back the initial investment.
LISA: the ISA with first-time buyers in mind
Last, but far from least, is the Lifetime ISA, also known as the LISA. This was created three years ago as a reboot of the Help to Buy Savings Account. It can be opened by anyone aged 18 – 39 and you can pay into it until you’re 50. You can pay in £4,000 per year and you get a 25% government bonus for every pound you save. So that’s a potential extra £1,000 per year.
The catch is: you can only take the money out as part of the deposit on your first home, if you are terminally ill and have less than 12 months to live, or to fund your retirement from the age of 60. If you take money out for any other reason there’s a withdrawal charge of 20%, going up to 25% from April 2021. This effectively claws back your tax boost.
Use your LISA as a pension?
For a young person who is a basic rate tax payer, without a lot of savings and aiming to buy your first property, a LISA could be a really good choice. Just like a pension, you can hold a broad range of investments, to suit your goals and risk appetite.
And what if you decide to leave your money invested until you retire? Does the LISA, with its 25% tax boost, provide an alternative to pension saving? Probably not once you start to earn more than the upper limit of the basic rate tax band – currently £50,000.
And if you can afford to put aside more than £4,000 a year, consider combining it with a pension pot or a traditional ISA. But bear in mind the £4,000 LISA investment will contribute to your annual £20,000 ISA limit.
So how do you decide which savings account(s) to open?
As we’ve seen, there is a really good range of tax-efficient savings accounts on offer. The one that’s right for you will depend on your overall financial strategy, your long-term objectives and whatever other savings and investments you have in place.
But with choices come decisions.
If you’d like some guidance with choosing your ISA and the most helpful mix of investments for you and your goals, a talk with a financial adviser could be very helpful in getting your ISAs, JISAs and LISAs in a row.
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