For the last 20 years, March and April have been a time for us to get our ISA affairs in order – topping-up ISA subscriptions for the tax year ending and funding ISAs for the year to come. But whilst the tax year end (5 April) stays the same, the considerations we have for ‘ISA season’ cannot afford to.
Traditional ISA season considerations
Since 1999, March has been a time for using or losing any remaining annual Individual Savings Account (ISA) allowances and looking ahead to the tax year around the corner. Heading into April you may have already had an idea of which Cash ISA was offering the best first year bonus next year and may have even considered whether it’s the right time to diversify into a Stocks and Shares (Investment) ISA, particularly as Cash interest rates began to tumble.
But with Cash ISA returns at persistently low levels (around 1%) and yields down on the more volatile Stocks and Shares ISAs too, is investing to an ISA each year still the ‘no-brainer’ it has always been? Tax-free or not, investments with interest rates lower than inflation (currently around 3%) are still losing value. Thankfully there is another way – another credible ISA asset class.
ISA evolution – more investment freedom
Innovative Finance ISA (IFISA) Managers are the relatively new kids on the ISA block. They are typically peer to peer (P2P) lending platforms, recently authorised by the Financial Conduct Authority (FCA) who offer attractive tax-free returns on loans they facilitate. And whilst awareness of IFISA (and P2P lending in general) is growing, it’s still not at the level it should be.
Depending on the platform, the peer to peer loans that comprise the IFISA investments, tend to be asset-backed – Proplend loans are secured by income producing commercial property for example. Like the Stocks and Shares ISA, capital is at risk but unlike its more traditional counterpart, investment values tend to remain constant and returns fixed. This may make the Innovative (Finance) ISA the more attractive investment ISA alternative for many people who are already comfortable taking some (capital) risk. If only more of us knew about it.
But if you’re reading this, perhaps with a few ISA pots from previous years, even if they’re ‘parked’ in Cash ISAs, you’re still in a better position than many. Awareness of ISA holders’ rights to transfer existing ‘pots’ to new ISA Managers and even new ISA types, is also worryingly lacking. Simply put, your funds don’t have to stay where they were first saved or invested – you’re free to shop around for better rates and comparison websites make this easier than ever.
Could this lack of awareness be a big reason why so many Cash ISA ‘savers’ are still missing out on higher returns and accepting nominal rates? Or are these merely the particularly risk-averse individuals who value the Financial Services Compensation Scheme (FSCS) capital protection above all else?
Whilst not covered by the FSCS, IFISA Managers tend to have alternative measures in place to protect against investor losses – for example Proplend hasn’t had any defaults or investor losses to date, albeit track records do vary between P2P platforms so it’s definitely worth checking this.
What’s changed …
Rather than just comparing Cash or Stocks and Shares ISAs, Innovative Finance ISAs should increasingly come into the equation when assessing the relative merits of the different ISA types and how to split annual subscription allowances between those asset types?
A change to ISA rules two years ago means that ISA monies don’t now have to stay ‘tied up’ within the ISA wrapper all year round – historically if you withdrew ISA funds they immediately lost their tax-privileged status. Enter the flexible ISA.
Although still very much in a minority, flexible ISAs like the Proplend IFISA allow investors to withdraw funds and return them by the end of the current tax year without losing their tax-free status. Whilst earnings on those funds outside of the flexible ISA are taxable, once they’re back within the ISA, returns on investments from these funds are once again tax free.
And with flexible ISAs, it’s not just current year subscriptions that can be withdrawn and returned – it’s previous year ISA monies too. Consequently, flexible ISA customers can benefit from having significant funds available to call on should their circumstances dictate. There’s no obligation to return all the withdrawn amount, no need to return it in one lump sum and no problem if the funds only come back in just before the end of the tax year.
New IFISA Managers are still being approved all the time and with an increasingly competitive and mature P2P lending market, the hope is that more of the new ISA products will offer this valuable flexibility. Speaking from experience, keeping track of flexible withdrawals and returns makes the ISA Manager’s life a little more complicated but for ISA customers that facility is certainly worth having for a rainy day.
What’s changed …
Many of Proplend’s ISA customers have already taken advantage of these new freedoms, so for them ISA season will also be about assessing how much of their outstanding flexible balance to return before the end of the tax year. Are they in a financial position to return all that they’ve withdrawn, or even return more than they’ve withdrawn and use some more of their annual allowance before they lose it?
Any withdrawals they don’t return by the end of the tax year will be treated (like traditional ISAs) as permanent withdrawals – we’ll be contacting them shortly about this. ISA participants in general will also need to be mindful of not breaching the overall subscription limit or the restriction of subscribing to only one ISA of each type each tax year. If they aren’t in a flexible ISA would they benefit from subscribing or transferring to one?
Record allowances and greater diversification
With more ISA investment choice and another £20,000 subscription allowance available from 6 April 2018 more ISA participants are having to consider how to deploy their ISA funds;
- How to split subscriptions across the types (asset classes)?
- How to split savings and investments across ISA Managers?
- How to avoid over exposure (risk) with any one shareholding, loan or bank?
- How and when to pay in funds – as much as possible as early as possible or in stages?
In reality, relatively few people will be able to afford to subscribe the full £20,000 right at the start of the next tax year. So, should we pay in as much as they can now and start earning tax-free on these funds ASAP, perhaps revisiting affordability next March? Or should we stagger subscriptions throughout the year to help ensure they don’t overstretch themselves and retain some capacity to participate in new opportunities that may present themselves later on in the year? There’s no right answer.
What’s changed …
As more ISA savers become ISA ‘investors’ and start to accept some capital risk, investment diversification has emerged as a bigger consideration for ISA season. How are your ISAs split across asset classes, ISA Managers and holdings – is your aggregate risk-return profile of your ISA portfolio one you’re comfortable with?
With the restrictions of subscribing to just one ISA of each type, each year, ISA transfers are a particularly useful portfolio rebalancing tool. 2018(-19) looks set to be the first year where the Cash ISA market contracts – a result of increasing transfers of existing pots, as well as a reducing share of new subscriptions.
Proplend does not impose any limits or fees on transfers in or out – we believe it’s a factor that encourages new investors to our platform and flexible ISA. But some ISA Managers do impose restrictions and it’s important to be aware of these, along with HMRC’s requirement to transfer all current year subscriptions in one ISA together.
In summary …
It remains to be seen how long the current Personal Savings Allowance (PSA) will be with us but Individual Savings Accounts are likely to be around (in one format or another) for many years to come. It’s important to be aware of all types of ISA out there as well as your transfer freedom. This will help you maximise your tax-free returns at a level of risk you’re comfortable.
None of us deliberately forego earnings but if you’re disengaged with the current returns on your previous year ISA pots or are ‘playing it safe’ with Cash ISA holdings only ‘earning’ 1 or 2% less than inflation, you are effectively missing out on higher returns. Despite income being tax-free, the real value of those funds (adjusted for inflation) is actually falling.
Just as Cash ISA holdings help offset the higher risks of investment ISAs, Innovative Finance ISA’s higher returns can strengthen the aggregate returns of your ISA portfolio. And even if you’re among the most risk averse, or reward hungry, some blending of the different asset types and diversification across providers and holdings is always worth considering. Remember; ISAs are for life – not just for ISA season. Don’t lose interest now!