Making the Most of Your ISA Allowance

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The COVID19 pandemic has highlighted the importance of having both cash savings and insurance (for all the complaints about the latter).  At the same time, it’s still important to prepare for the future, especially your retirement.  Your ISA allowance could be used for both purposes, but that may not be a good idea.  Here’s what you need to know.

Niche ISAs can have a sting in their tail

When ISAs first started, there were only two options, cash or stocks and shares.  The latter was marketed under various terms (e.g. investment ISA), but all ISAs had to be run to essentially the same set of rules.  Then the government started to create new forms of ISA for more niche purposes.

Arguably, the introduction of the Junior ISA (for children under 18) was a reasonable step.  The introduction of some of the other products has been, however, more questionable.  For example, the Help to Buy ISA could only be used (without penalty) once contracts had been exchanged.  This flaw was rectified with the Lifetime ISA, but this brought its own issues.

Firstly, the Lifetime ISA is designed for either buying a first property or saving for a pension.  These are very different purposes and it’s a very open question whether or not the Lifetime ISA is the best retirement-saving vehicle for the average person.  Secondly, money in a Lifetime ISA can only be withdrawn without penalty to buy a house or upon retirement.

Standard ISAs are straightforward products

Cash ISAs now work in essentially the same way as regular savings accounts.  Stocks and shares ISAs are somewhat more complicated, but no more so than any other share-dealing platform.  In fact, there’s a strong case for arguing that they’re simpler because they spare holders the pain of having to deal with tax documentation.

At present, that last point may actually be one of the strongest arguments in favour of opening a stocks and shares ISA.  As is being pointed out with increasing frequency, there is absolutely no question that COVID19 is going to generate a hefty bill.  There are, however, all kinds of questions about who is going to pay it and by what specific means.

Protecting your investments from future taxation

Two options stand out – “sin taxes” and wealth taxes.  The problem with sin taxes is that increasing them motivates people either to give up the sin or to get their sinful goods by illegal means.  The former may be good for the NHS over the long-term, but it doesn’t help the exchequer in the short term.  The latter is bad for both the NHS and the exchequer.

That leaves wealth taxes, such as income tax, dividend tax and capital gains tax.  In theory, raising income tax could be a lucrative move, but it could also be a controversial one.  This leaves dividend tax and capital gains tax as the stand-out options.

Making the most of your ISA allowance

In principle, you can hold your entire ISA allowance in cash, in stocks and shares, or in a mixture of both.  In practice, however, it’s hard to see a justification for using your ISA allowance for your cash savings.  Interest rates are negligible and could potentially go into negative territory.  This means that interest income is practically non-existent.

This leaves stocks and shares as the obvious choice.  The fact that you may see less dividend income than you’d like is a strong argument for keeping as much as you can of anything you do receive.

Similarly, if you want, or need, to sell shares then you want to keep as much as possible of the money for yourself.  This could become a significant issue over the next year or two as the (post-)pandemic environment plus Brexit could make for a lot of market volatility.

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