How to pick the perfect ISA

We unravel the bewildering range of ISAs available to help you pick the best one for your money... just in time for the tax year end.

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Individual savings accounts (ISAs) used to be fairly simple; cash accounts or stocks and shares, with the allowance capped for each option and limited movement between the two.

Fast forward to the present day and there are four ISA brands, with another one about to launch.

And this has caused some confusion among savers. Nici Audhlam-Gardiner, managing director at Saga Investment Services, says: “So many changes have been made to the ISA system over recent years that people are struggling to understand the rules. Britain needs savers of all ages and keeping things simple is the best way to encourage understanding and action. 

“So we are calling for a wholesale simplification of savings - one ISA account for all ages, the same terms and benefits for any purpose.”

An over-abundance of ISAs

There are now cash ISAs, stocks and shares ISAs, Help To Buy ISAs, Lifetime ISAs, Innovative Finance ISAs and Series Of Unfortunate Events ISAs – okay we made that last one up.

But it’s important to remember that the premise of every ISA is simple – it’s a tax-free account where you can shelter your savings or investments and the taxman can’t touch the returns.

There’s a limited amount that can be saved each year - £15,240 in the current tax year but it rockets to £20,000 in 2017/18. That amount can be saved into one type of ISA or divvied up among the various options.

So here is a quick rundown of the types of ISA on offer and who they are suitable for.

Cash ISA

This is the most popular type of ISA and the easiest to understand. Cash goes in, cash plus interest comes out.

Cash ISAs are as simple as standard savings accounts; you can have a regular saver, easy access account or fixed-rate bond. And, as with any ISA, you can add to the total each year until you have a vast store of tax-free wealth – or you can simply use it to stash whatever you can afford to save.

This is a good ISA option for people who don’t like risk, who want to know exactly how much they have at any one time and who are not saving for their first house or for retirement.

As long as the account allows instant access to cash, it can be a good place to keep an emergency fund. Just make sure that doesn’t max out your allowance and prevent you investing in a tax-free account for the long-term.

Stocks and shares ISA

It’s also possible to invest in funds, bonds and shares, and still keep it all in a tax-free wrapper, meaning there will not be any capital gains tax to pay on any profits.

You usually open a stocks and shares ISA via a fund management group, online broker or fund supermarket, although some will charge fees for opening and managing your account.

With any investment there’s a risk that the value could rise or fall, so this is not the right account if you are risk averse or if you plan on withdrawing your investment in the near future.

These accounts are best for long-term investment so that a sudden dip in the stock market doesn’t wipe out your wealth just as you need to withdraw it.

Innovative finance ISA

A lot of people have been investing their cash into peer-to-peer lending opportunities via websites such as Zopa and Ratesetter, with many platforms offering better returns than the lacklustre savings market.

Although this new kind of ISA was launched last April it has not been easy to invest in one so far, as providers scrambled to get approval from the Financial Conduct Authority. However, many are now open for investment so 2017/18 is likely to see real growth in account take-up.

Some of the biggest P2P lending platforms have not yet launched, though, so some investors may prefer to hold back until the market has filled out more.

These accounts are best for investors who understand the peer-to-peer lending market and are comfortable with the risks involved.

Help To Buy ISA

These cash ISAs are designed to help first-time buyers save a deposit for their first home and can be used to help buy a property worth up to £250,000 – or £450,000 in London.

Help To Buy ISAs are regular saver accounts and it’s not possible to save more than £200 a month into them, although you can add £1,200 in the first month.

When the money is used to buy a first home the government will top it up with a 25% bonus out of the public purse, up to a maximum of £3,000. To get the full bonus savers would need to save the maximum amount for four-and-a-half years.

This kind of ISA is a good idea for anyone saving for their first home. Be aware that this counts as a cash ISA, so it is not possible to save into both a standard cash ISA and this kind of account in one tax year. Some providers do let savers split their ISAs, though, and hold more than one ISA product in their cash ISA account.

Lifetime ISA

The new account on the block launches in April and it’s another account that offers a free government top-up. But it comes with a pretty severe health warning.

It was announced by George Osborne in what turned out to be his final Budget and it’s designed to help the under-40s save more for either their first home or their retirement.

The government will top up savings held in these accounts by 25%, although a maximum of £4,000 a year can be saved. That means there’s an annual £1,000 of government cash up for grabs.

It will be paid each year until the account holder reaches 50, meaning an 18-year-old could pocket £32,000 in bonuses if they saved £4,000 a year until they reached 50. That could happen, right?

However, a big financial health warning is needed. The money is tied up until the account holder reaches 60, unless they want to use it towards their very first home. So, if the account holder suddenly needs cash, they can’t access their Lifetime ISA savings without paying a 25% penalty on withdrawals.

That doesn’t just remove the bonus; it also takes a penalty out of the money you yourself invested.

The Financial Conduct Authority has set out a number of warnings that providers will have to offer, including the impact a Lifetime ISA might have on pension savings and how savings might affect benefits eligibility.

This ISA account is really only suitable for people under the age of 40 who are really, really clear on its limitations.

First time ISA investing: 3 must do's

“Investing can appear complex because of the wide range of choices available and unfamiliar terminology," says Adrian Lowcock, investment director at fund manager, Architas. "However, a lot of this can be made easier by taking a bit of time before you make your first investment to know what you want to achieve from it and understand the costs associated with investing.”   

1.       Have a plan

"Before you invest, set yourself a plan, write down what your objectives and aims are from your investments, how long you are looking to invest for and if you will be investing more money each year.  Review the plan and fine tune it adding in your ability to tolerate risk and revisit this plan every time you consider changing your investments or making new ones."

2.        Choose the right platform

"First time investors are spoilt for choice with platforms at the moment, and trying to compare one with another can be complicated and what may suit first time investors now may not suit them in the future. So pick a platform that does what you need – If you are only looking for funds, as opposed to individual shares, inside your ISA then all you need is one that offers this. Make sure the platform doesn’t charge any exit fees as this means if you choose to leave and move to a platform more suitable to your needs you can."

3.       Diversify your investment

"Often, first time investors are attracted to individual shares having seen or heard stories where investors have had huge successes. However, investing in individual shares can be risky, for every success there will be plenty of disappointments you don’t hear about.  Instead first time investors (and experienced investors for that matter) can benefit from using expert fund managers who have significant investment experience and will provide diversification by investing in a number of companies through their funds."

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