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Chapter 1
Saving the day? Isas are more valuable than ever
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May 2020
How advisers are making the most out of tax-efficient savings
The future of
ISAs
by Laura Miller
It’s one of the most basic tenets of financial planning: max out your Isa allowance, and deal with everything else after that. Along with paying off corrosive debts and saving as much as you can into your pension as early as possible, it’s never far from the top of the list of must-do’s that advisers up and down the UK hammer home to us journalists and their clients. But are savers really taking advantage of the significant tax efficiencies an Isa provides?
Introduction by Justin Cash - Editor, Money Marketing
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Q&A with Director of specialist business support, Prudential
Chapter 2
Vince Smith-Hughes
For more information about the new Prudential ISA online service visit www.pruadviser.co.uk/isaonline
Website link to go here her here?
Justin Cash
INTRODUCTION
It’s one of the most basic tenets of financial planning: max out your Isa allowance, and deal with everything else after that. Along with paying off corrosive debts and saving as much as you can into your pension as early as possible, it’s never far from the top of the list of must-do’s that advisers up and down the UK hammer home to us journalists and their clients. But are savers really taking advantage of the significant tax efficiencies an Isa provides? With the lifetime and annual allowances for pensions saving also proving a real ceiling for many professionals, advice on getting the most out of their Isa can prove particularly valuable in the present climate. But few things about tax treatment remain certain. Will the government’s ever-shifting priorities look to Iast as their next port of call for review? We hope this supplement provides some useful scene setting for advisers discussing Isas with clients, while offering practical hints on what best practice looks like and inspiring a discussion about the path ahead.
Editor, Money Marketing
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Will the government’s ever-shifting priorities look to Isas as their next port of call for review?
While March’s Budget hed the standard Isa limit at £20,000, the tax-free amount for the Junior Isa, along with that for the Child Trust Fund, was more than doubled, from £4,368 to £9,000. Evidently this presents a significant opportunity for financial planners, particularly as other tax wrappers such as VCTs and EISs draw more scrutiny and risk being hit hard by current market volatility and macroeconomic headwinds.
As worried households focus on making their savings outlast the pandemic, Isas are more valuable than ever – but consumers need advice on the best one to choose
SAVING THE DAY?
The end of March typically heralds a new financial year. There is normally a rush of last-minute returns to HM Revenue and Customs, and hasty efforts to fill up an old Isa before a fresh allowance, currently £20,000, arrives on 6 April, to grow free of capital gains tax. This year things were different. Coronavirus, already raging across Asia, then Europe, by March had arrived in the UK. Now financial concerns for many households have veered towards making savings last while wages are cut – by 20 per cent at best or, at worst, completely. “I expect Isas to continue to be popular,” says Kay Ingram, director of public policy at national IFA LEBC. “Few rules and restrictions mean the public are confident about investing in Isas, and understand they provide income and growth tax free without restricting access.” Research by Boring Money, the consumer financial education site, suggests almost half of UK adults have an Isa of some type. Holly Mackay, managing director at the firm, says: “Isas are a well-understood, core bedrock for saving; although, the more tinkering, the more room for confusion, as with Lifetime Isas.” Anyone aged 18 to 39 can open a cash or stocks-and-shares Lifetime Isa and invest up to £4,000 a year towards their first home or retirement. The government adds a cash bonus of up to £1,000 a year. However, any withdrawals, except to buy a first property or after age 60, have been subject to a poorly understood 25 per cent penalty: the bonus plus 6.25 per cent of what you contributed. On 5 May, responding to the financial impact of coronavirus, the Treasury effectively removed the early withdrawal penalty until next April. “Those on reduced pay or made redundant may need unexpected access to their savings,” says Ingram, who hopes the measure will become permanent because “it has always seemed unfair and we know it is a barrier to some savers taking full advantage of the Lifetime Isa”. Ingram urges the government to resist the temptation to create any additional Isas for specific purposes, arguing they complicate investors’ choices. Advocates for a Care Isa, for example, claim with a taxpayer subsidy attached it could entice individuals to save towards their long-term care while government dithers on a comprehensive solution to this rising expense in an ageing population. “In practice, consumers don’t want their savings and investments siloed in this way,” says Ingram. “No one wants to save exclusively for something they do not wish to happen and may never need.” The current role of Isas in financial planning varies. For Stocks, on a basic level, “combined with the other two allowances – personal savings and dividends – Isas enable us to shelter assets that would otherwise have distributions taxed”. For pre-retirement clients, he invests their money in Isas without the access restrictions of pensions – sometimes in investments that may become future pensions. For clients in retirement, Stocks uses Isas as a secondary pot to take ad hoc tax-efficient income to top up taxable income. “Do most people need ongoing advice on a sensible Isa accumulation strategy that sees them pay a percentage of assets, year in, year out?” queries Mackay. “There is a lot more we could do to just help investors with smaller Isa balances to select a sensible mix of funds that have a decent probability of delivering outcomes for their timeframes.” For some groups – the self-employed, full-time carers or part-time workers who cannot benefit fully from auto-enrolment pension schemes – Isas can be simple but effective financial planning. “These groups are predominantly female,” says Ingram. “Isas give equal access to all, regardless of employment status, so they can help close the pension gender gap.” To benefit further, however, women may need to move out of the far-below-inflation rates on offer in cash Isas. Boring Money found around 40 per cent of men and women had a cash Isa, but 17 per cent of men had a stocks-and-shares Isa compared with only 10 per cent of women. Even if women remain reluctant investors, they could benefit from a recent Isa innovation: the right of a surviving spouse to inherit an additional Isa allowance, equivalent to the value of a deceased spouse’s or civil partner’s Isa funds. Fresh Isa launches and improved inheritance rights are hard to read across directly to take-up. But small-scale investors are continuing to come into the market. Fourteen per cent of stocks-and-shares Isa holders have less than £1,000, according to Boring Money. It found mobile trading was emerging as an increasingly popular entry point. Eighteen per cent of stocks-and-shares Isa holders bought or sold investments on a mobile device in the past year. New entrants and long-time savers alike will have to keep their nerve in the coming months. The UK, like much of the world, is entering a recession on the back of the pandemic. The Bank of England’s baseline scenario for the first half of 2020 is a near-30 per cent drop in GDP – a 300-year low. Non-Isa savings accounts are actually paying more interest than cash Isas right now, so Ingram recommends putting short-term, easy-access savings outside an Isa. “Then invest savings for the medium-to-longer term in stocks and shares, to achieve the potential of higher returns over that longer period,” she says. Markets may be volatile now because of coronavirus, but savers who drip-feed regular investments into stocks-and-shares Isas are likely to end up better off. Coronavirus losses will be mitigated by the cushioning impact of ‘pound-cost averaging’; benefiting from exposure to the market in small chunks and, where there is a fall in the value of assets, by buying at a lower price. “In times of economic uncertainty, investing little and often can help smooth out the peaks and troughs of market highs and lows, and reduce the risk inherent in investing,” says Ingram. She suggests novice stocks-and-shares Isa investors combine drip-feeding with a multi-asset approach to diversify the risk. Stocks recommends Isas as a way of guarding against complacency over interest rates, currently at a record-low base of 0.1 per cent. “Interest is now paid gross and subject to the savings allowance,” he says. “Those not using Isas may have taken for granted the tax position of their interest. They may be in for a surprise and regret all the Isa years they’ve left unfunded if interest rates rise and they find their interest is now liable to tax.” Ingram also has an eye on the future in her top tip. “Far too many Isa savers are in cash,” she says. For longer-term savers a stocks-and-shares Isa is vital, “especially if saving for children who cannot access the funds till they are 18”, because parents can pay in up to £4,000 a year using a Junior Isa. Ingram adds: “The impact of inflation, and the need to take some investment risk to have a chance of achieving real-terms growth, should be paramount.”
There is a lot more we could do to help investors with smaller Isa balances to select a sensible mix of funds
Isas are a well-understood, core bedrock for saving
Almost 13 million UK households have between zero and £1,500 in the bank, according to The Money Charity. Individuals average £4,200 in unsecured debt. Savings accounts such as Isas are needed more than ever. For some, lockdown is an opportunity. Analysis by the Centre for Economics and Business Research found on average households were spending £795 less per month than they had been pre-lockdown – a 30 per cent drop. That money could find a home in an Isa.
The Lifetime Isa was launched in 2017 as a half-way house between saving for retirement and helping first-time buyers build a deposit. Take-up has been modest; Boring Money data suggests 13 per cent of UK adults have a stocks-and-shares Isa, but only 3 per cent have a Lifetime Isa. “Hopefully the future is one of simplicity for Isas, but the trend has been quite the opposite,” says Dobson and Hodge IFA Paul Stocks. “The Lifetime Isa unnecessarily muddied the ‘pension versus Isa’ water.”
Pausing the penalties
Product development problem?
In practice, consumers don't want their savings and investments siloed in this way
Small-scale investors are continuing to come into the market
On average, women outlive men by around four years but on a pension a third smaller, so the change could improve their financial future considerably. “If the pension-poor spouse or partner is the survivor of the couple, they often face a significant drop in pension income,” says Ingram. “But now Isa income can continue undisturbed at the previous level.”
New kids on the block
Introduction
by Justin Cash
“It’s important investors consider what they are holding in which taxable environment,” he says, “because a little bit of planning can make things much more tax efficient.” Just under a quarter of over-65s have a stocks-and-shares Isa, according to Boring Money data. For ages 55 to 64 the figure falls to 17 per cent, and for 18- to 54-year-olds it is one in 10. By comparison, half of over-65s have a cash Isa, 39 per cent of 55- to 64-year-olds, and a third of those aged 18 to 54.
We recently moved our Isa to an online service for withdrawals, top-ups and new applications
Q&A: Director of specialist business support, Prudential
ISAs: the go-to wrapper of choice
There are already many different forms of Isa, including Innovative Finance Isas, Lifetime Isas and Junior Isas, so there is a significant choice. It’s not easy to innovate in the current climate in terms of product design – for example, with current low interest rates having any sort of guaranteed element could be disproportionately expensive relative to the benefit. In terms of a different approach, smoothed funds do at least give some protection from the ups and downs of daily volatility, which is obviously more prevalent than usual at the moment. This can give clients more peace of mind if they are investing in a stocks-and-shares Isa. Innovation can take place, however, in operational areas. For example, we have recently moved our Isa to an online service for new applications, top-ups and withdrawals, along with other initiatives to help advisers service their clients more easily and effectively. There is still a view held that Isas should be the first choice for retirement savings, and in some cases that could of course be true. However, for those who are able to save into a pension, the tax-free cash and potentially higher tax relief on the way in than tax paid on the way out still provide an advantage in many circumstances. Any contributions that are matched by employers make pensions even more attractive. However, Isas can be really valuable as a means of providing tax-free income in retirement, which can supplement other sources of income. One other common misconception concerns the protection afforded by the Financial Services Compensation Scheme, which can vary greatly according to what type of Isa is being considered. Understandably, in uncertain times questions of this nature are asked more frequently. For example, many people don’t realise that investment into PruFund via our Prudential Isa is regarded as a life insurance policy and thus they’re protected 100 per cent in the unlikely event of Prudential Assurance Company Limited being ‘in default’. The value of any investment can go down as well as up, so your customer might get back less than they put in. It’s possible, but that may not lead to good outcomes for customers. Returns from equity-based investments are likely to have performed better over time, even allowing for significant falls in the market such as the financial crisis of 2008 and the recent falls caused by Covid-19. This is where bespoke advice comes to the fore as advisers will be taking into account what the client’s investment time horizon is. Holding money in cash Isas is very unlikely to even keep pace with inflation over the longer term. People investing regularly will, of course, have the advantage of pound cost averaging and this should also not be overlooked. Given their attractiveness, Isas will continue to be at the fore of adviser recommendations, either for new investments or for providing a tax shelter for existing investments. Although contributions are limited, a couple can save £40,000 into Isas between them, which is not an insignificant sum. One other point worth mentioning is that Isa ‘switching’ is now a market in its own right as advisers seek to obtain the most appropriate investment vehicle for what is often a significant sum of money. Many clients are often reluctant to invest directly into stockmarket-linked funds without any safeguards. For more information about the Prudential Isa and new online service, visit: www.pruadviser.co.uk/isaonline The Prudential Isa is provided by Link Financial Investments Ltd
What are your top tips for advisers looking at clients’ Isa portfolios? It very much depends on what the client’s needs and objectives are. For those who are accumulating, most advisers would be recommending clients stay in the market to benefit from the recovery if/when it comes. It’s a bit trickier for those who are decumulating or may need the funds in the short term. Many Isa holders will be using these funds for income as often advisers are looking at investments outside pensions as the first port of call to pay retirement income, because funds left in pensions are usually able to be passed down the generations more easily and efficiently. Those who are decumulating their Isa funds need to be careful about the effects of taking income from funds that have significantly reduced – effectively they are crystallising the loss. It may be possible to temporarily reduce income or replace it from resources held elsewhere if that is the case. As mentioned above, since the pension freedoms came in many people have been using Isas ahead of pensions to pay income. This has created a different dynamic from what fund advisers are recommending, as they need to think about sequencing of return risk as well as other factors. Another aspect that advisers are considering is whether accumulated funds and ongoing contributions should be treated in a different manner. As Isas (and Peps before them) have now been around for many years, a lot of savers have significant funds held in Isas and, for understandable reasons, are prepared to take less risk with a large capital sum than with ongoing contributions. So, for example, we have seen transfers coming into our Isa into our smoothed funds, but with ongoing monthly contributions going into collectives. Finally, the wide availability of fund ranges – to suit different attitudes to risk or even a client whose attitude to risk changes – has broadened the appeal further.
What are your top tips for advisers looking at clients’ Isa portfolios?
Have you seen much change in how advisers and clients are using Isas in the past few years?
Do we need more product innovation in the market, or better rates?
What misconceptions are you still seeing about how Isas work?
Isa ‘switching’ is a market in its own right as advisers seek the most appropriate investment vehicle
There is a relatively generous allowance for Isas of £20,000 per annum per individual, which has increased over the years, so many people will not be able to save the maximum. However, advisers often take the opportunity to move other investments into an Isa wrapper to shelter the investment from unnecessary tax in the future. Isas are a very important part of portfolios and advisers use them as one of the go-to tax wrappers of choice, perhaps only second to pensions in the normal course of events. There are, though, some situations where other tax wrappers may be an attractive alternative. For example, an offshore bond under trust can provide parents with more control when their offspring reaches 18 than they would have under a Jisa.
Is everyone making the most of their tax-free allowances?
What role do Isas play as part of a wider, tax-efficient portfolio?
Do you think we’ll see a flight to cash Isas, rather than market-linked ones, as a result of all the Covid-19 volatility?
How optimistic are you that strong flows will continue into Isas in the future?
Vince Smith-Hughes is director of specialist business support at Prudential. He has worked in the financial services profession for over 30 years, and has previous experience as an IFA as well as holding senior roles at Clerical Medical and Winterthur Life. Vince is an experienced platform presenter at industry events and a regular contributor to trade and national publications on financial planning matters. He is a fellow of the Personal Finance Society. Vince lives in EastAnglia with his wife and son.
Biography
May 2019
The 10-year Treasury yield
This puts it ahead of inflation, meaning that investors are receiving a positive real return from government bonds.
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