Anyone planning to put money into Individual Savings Accounts (ISAs) during the current tax year now has just one month to meet the deadline of midnight on Sunday 5 April. An annual maximum of £7,200 can be invested in these tax-efficient products, up to £3,600 of which is allowed in a cash ISA.
But the question is whether people should even bother, considering that interest rates have plummeted dramatically and the vast majority of equity investments have also lost money over the past couple of years.
Not only are some cash ISAs paying a miserly 1 per cent, but stocks and shares ISAs have been badly affected by the recession, financial crisis and plunging global stock markets.
Andrew Merricks, head of research at Brighton-based Skerritt Consultants, agrees it has been a tough time for most investments, but insists the tax advantages of ISAs mean they should still be considered by anyone with money to save.
"ISA holders have been hit by the double whammy of capital and income falling – and there's no magic wand to replace it," he says. "People are seeing the value of their savings fall dramatically, but it's all about making the most of what they have got."
What you need to know
Following regulatory changes last year, ISAs can now be split into two distinct camps: cash ISAs, available to people 16 and over; and stocks and shares ISAs, for which applicants need to be a minimum of 18.
Cash ISAs are basically tax-free savings accounts that are offered by most banks and building societies. Interest is paid on a regular basis which means you will not lose money, although you'll need to make sure you're earning more than inflation.
Of your total annual ISA allowance, up to £3,600 can be invested this way.
Stocks and shares ISAs, meanwhile, can be invested in assets such as open-ended investment companies or individual shares. You can invest up to the full £7,200 annual limit, but as it will be exposed to stock markets, the value of this investment can fall as well as rise.
Any income generated by a cash ISA is tax-free and doesn't have to be declared on your annual return. There are similar advantages with stocks & shares ISAs, although there are a few important differences, too.
If you buy ISAs that invest in income-generating funds, such as corporate bonds, then you won't have any income tax to pay. However, dividends on equities are paid net of basic rate tax, in exactly the same way as they would be in a non-ISA product. Either way, you will not have to pay capital gains tax on any returns generated in an ISA.
Despite these attractions, relatively few people invest in ISAs. Of the almost 50 million people eligible, only 18 million have actually opened one – and that figure is expected to dwindle as people become disillusioned by returns.
A study by uSwitch.com suggests that a staggering 4.3 million consumers are planning to ditch their cash ISAs. Around half are doing so in protest at interest rates; 18 per cent claim they need the money; and four per cent are adamant they can get a better deal in a non-ISA savings account. This could be a foolhardy move. A staggering £263m in potential tax savings is already being wasted every year by people not investing in these products, according to research by Unbiased.co.uk. Once investors shun their annual allocation, there is no going back, adds Geoff Penrice, an adviser at Bates Investment Services. Even though returns have been lacklustre of late, that doesn't mean ISAs should be ignored.
"Even though rates on cash ISAs are low – which makes the tax benefits less appealing – they will increase in time as the economy recovers," he says. "The point is that if the annual allowance is not used it cannot be carried forward."
So what should you do?
The golden rule for cash ISAs is to shop around because rates vary enormously between rival providers, according to Kevin Mountford, head of savings at the comparison website Moneysupermarket.com.
"It is certainly not all doom and gloom, as we are seeing a few new products coming onto the market paying around 3.5 per cent – substantially higher than the base rate," he says. "You would be hard-pushed to find a non-ISA product that pays you a better rate on a net basis. On the other hand, some accounts are offering just 1 per cent."
According to the Moneyfacts.co.uk comparison site, Marks & Spencer has the best easy-access cash ISA, paying 3.1 per cent; you can get 3.35 per cent with Halifax if you're willing to tie your money up for four years. Beware, however, that after Thursday's rate cut, it is likely that easy-access ISA rates will be cut.
Stocks and shares ISAs
The market gyrations of the past year means that £70,000 invested over the course of the past decade would now be worth just £61,744.86 on average, according to Moneyfacts – a fall of £8,255.14. However, some funds have performed significantly better. The same amount invested in the SW Latin American Fund, for example, would now be worth £124,100, while someone who had invested in BlackRock Gold & General would be sitting on a whopping profit of £98,784.
So where should people be investing their allocation? According to Darius McDermott, managing director of Chelsea Financial Services, it all depends on an investor's aspirations and their attitude to risk. Only when these have been answered can a decision be made.
"Over the longer term – at least five years – equities look a raging bargain right now, though it could still be very tricky over the next two years," he says. "However, if you're prepared to accept a bit of volatility, then they are the way to go."
Even so, they are unlikely to turn a profit in 2009. "The products likely to make money this year are the best of the absolute return funds, such as BlackRock UK Absolute Alpha and Cazenove UK Absolute Target Fund," he says. "They have all got good prospects of making a positive return over the coming months."
Andrew Merricks at Skerritt Consultants suggests looking at fixed-income products. "ISAs remain tax-free when invested in corporate bond funds," he says. "They are producing up to four times more income than their cash counterparts. So is it really risky to invest at these levels if you need an income?"
Of course, you don't have to stick to the same products. Changes brought in last year enable investors to transfer money from cash ISAs into stocks and shares ISAs (though not the other way round).
Although transferring your money may be wise, it's important that you don't take it out in order to move it yourself. Any cash withdrawn will be treated as a fresh investment when it is paid into your new ISA, and thus restricted by the annual limits.
Switching cash into a stocks and shares ISA can certainly make sense for those people who want to see their money working harder, says Rob Fisher, head of UK Personal Investments at Fidelity International. By the end of the last ISA season, the average interest rate on cash ISAs was 4.8 per cent, he points out, which means someone making the average investment of £2,200 was enjoying a projected annual income of £105.82. This is now down to £46.20. "This jump is significant, and investors will need to make sure that they fully understand the risks involved," Fisher says. "However, for those wanting to maintain their level of income, this course of action may be a solution to their problems."
Be careful that you don't inadvertently breach the ISA limits, warns Hugo Shaw, business manager at Bestinvest. "You cannot rely on your ISA manager to stop you exceeding ISA subscription limits," he says.
"If you've separately taken out a cash ISA as well, then responsibility for keeping within the allowances sits firmly on your shoulders, whether you're making one-off or regular subscriptions."
ISAs that have breached the limit are known as invalid accounts. Holders will need to contact the HMRC's ISA helpline at 0845 604 1701, and its staff will decide what action should be taken and advise them accordingly.
Diversification is the key to success, says Geoff Tresman, chairman of Punter Southall Financial Management. He suggests investors look carefully at both asset allocation and geographical distribution.
"Do not put all your eggs in one basket, and include some overseas exposure, such as the Far East, US and emerging markets," he says. "Also look at including other asset types to your existing equity holdings, like fixed interest."
For those with a balanced attitude towards investment risk, Tresman suggests having 40 per cent in fixed interest, 35 per cent in UK equities, 20 per cent in global equities and five per cent in resources. "Those people investing into equity markets will undoubtedly see a fall in value at some point over the next 24 months because of the continued volatility, but over the medium term I see a great deal of value," he says.
Whether you opt for a cash ISA, a stocks and shares ISA or a mixture of both, Andrew Barker, chief operating officer at Skipton Financial Services, is adamant that everyone should make the most of the opportunity to invest in these products.
"Alistair Darling and his cronies at the HMRC are quick to hit you with stealth taxes but your annual ISA allowance is one tax-efficient gift you do receive," he says. "It should be an essential part of your investment portfolio."