Investing — Overview of ISA’s
What is an ISA? What types of ISAs are available? How do you get an ISA? Why should I get an ISA? all questions this article will try to answer for you.
Investing is a minefield of both challenges and opportunities with an uphill challenge that seems impossible to learn and only left to professionals that have studied for years to get where they are. This is not all true, professionals in the field of finance are still human like you and me. It only takes time and commitment to understand, potentially making you money — hopefully losing as little as possible.
So what is an ISA?
When investing one of the main things to remember is to keep any costs as low as possible and that includes any taxation that you will have on your savings and investments. ISAs are something of a black box where the tax man has no chance of getting access to your money by taking tax from your investments. The only caveat is that the money you put into an ISA is net of your income, this is different from pensions where tax is taken as income when you start to withdraw your pension funds at the time of retirement and any money put in is gross of your income.
What types of ISAs are available?
First up is a “Cash ISA” — risk level 1/10, This is something your bank or other financial institutions can provide. They generally run at a fixed rate with others changing the rate depending on the bank base rate. As of writing, Zopa has a rate of 5.08%, Virgin Money has a rate of 5.06% and Chartered Savings Bank has a rate of 5.03%. You do need to be careful with withdrawing your money once your cash is in the ISA due to some will drop the rate by as much as 2%.
Pro’s
- fixed rate so you know what you will get back
- secure in the knowledge you will not lose money
Con’s
- not possible to select what you invest in
- unable to make more than the fixed rate
Next is a “stocks and shares” ISA - risk level 5/10. This is where you have a portion in cash and the rest you invest in shares (company stocks) and/or funds of your choosing. This can be much more profitable than a purely cash ISA although it does open the door to you losing money. If you are willing to learn and willing to take at least a small amount of risk then go for it! I have a Cash and shares ISA and yes I have lost but also gained a lot from my investments yet made more than the current cash ISA rates. The brokerage I use is Tilney Bestinvest but there are others such as Hargreaves and Lansdown both offer a wide variety of funds and access to local and international companies to invest in.
Pros
- can invest in what you like either funds and/or stocks
- could make a lot more than a cash ISA
Cons
- could lose a large amount of your money
Next the “Innovative Finance ISA”- risk level 8/10. This is a rather unique type of ISA where you can use your cash to invest in peer-to-peer networks which allows you to lend funds while not paying a penny of tax. The rates can vary but you could earn up to 7.51%. It is a high-risk venture due to its nature you are loaning your money, to decrease your risk I would spread your cash across multiple loans.
Pros
- higher chance of increasing your return
Cons
- much riskier than a cash & shares ISA thus you could lose some or all of your money
Next is the “Lifetime ISA” — risk level 5/10. This can be opened from the age of 18 up to 40 years of age. You have a limit of £4,000 that you can put in per year and the government will add 25% to each cash sum placed into the ISA up to a maximum of £1,000. This can be a purely cash ISA or both cash and stocks. There is a maximum age of 50 where you can put cash into the ISA but you will be able to still keep the ISA open and continue to invest.
Pros
- 25% will be added by the UK government on cash-added
- if it is a Lifetime stocks and shares ISA you can choose your investments to invest in.
Cons
- maximum of £4,000 per year
- will count towards the overall ISA yearly limit
ISA’s compared to Pension’s
There are differences associated between ISAs and pensions. Below I have listed the main differences:
ISA’s…
- cash is added after it has been taxed from your income (net)
- maximum of (23/24 tax year) £20,000 per year
- When taking out the money it is not taxed
Pensions…
- cash is added gross of your income
- when retiring and taking money out it is taxed as an income, this can be an advantage due to you will most probably earn a higher rate during your career and then have an income from your pension at a lower rate.
- any money added to your pension has an additional 25% (as a basic rate taxpayer) of that amount added by the UK government.
- There is a lifetime limit of £1,073,100 as of the 23/24 budget
Usually, it is advised to add as much as you can to your pension taking full advantage of the 25% (basic rate taxpayer) added by the government and only once you reach the limit do you have an ISA. For me, I tend to separate my cash into both a pension and an ISA.
Why should I get an ISA?
This question remains because if a pension offers 25% on any cash added and you potentially have all the types of investments that a cash and shares ISA has on offer, why choose an ISA? this is a personal question but I tend to think of an ISA as cash only to be touched if you need it for an emergency and at no other time until you retire — such as losing your job. Thus 25% of my income goes to an ISA and 75% goes into a pension. The only caveat is if you do not have the will to not touch it for anything other than an emergency, place 6–12 months’ worth of your income in an ISA and once reaching this put all cash you can into a pension.
ISA compared to a savings account
To briefly explain there is a difference that will make in the long term a substantial increase to your investments and cash available in the future. As mentioned ISAs are not taxed but when it comes to savings it is taxed. Do you want to give money away to the tax man that you could avoid?
To prove to you the advantage compared to savings, to calculate the amount of interest you will gain you need to multiply the interest from the ISA by:
- 1.25 if you are a basic taxpayer
- 1.66 if you are a higher-rate taxpayer
- 1.82 if you are a top-rate taxpayer
So if I were to have 5% interest on my ISA, this would require a savings rate of 6.25% to be equivalent.
ISAs are great and so are Pensions but use them wisely and think about your needs, mine is sure to be different to your financial requirements. and if you are unsure or do not have time to research investing, then speak to a Financial Advisor until you are confident you know how to invest and what to invest in. Enjoy your investing journey!
Important Disclaimer: I am not a financial advisor, nor am I an investment advisor. All information contained within this article is from my personal experiences over the years with investing. Remember, unless you invest cash with a financial institution such as a bank on a fixed interest rate then you could get back less or even none of the invested money.
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