Cadence Wealth Limited is an appointed representative of Intrinsic Financial Planning Limited and Intrinsic Mortgage Planning Limited, which are authorised and regulated by the Financial Conduct Authority. Intrinsic Financial Planning Limited and Intrinsic Mortgage Planning Limited are entered on the FCA register under reference 440703 and 440718. Registered in England and Wales, No: 10040034. Registered address:The Tanneries, 55 Bermondsey St, London, SE1 3XJ
Personal Allowances and ISA's
By Kara Bowman
How do the changes in Personal Savings Allowances affect your approach to investing?
So how much is the personal savings allowance?
Tax treatment varies according to individual circumstances and is subject to change.
If I’m already saving into a tax-free account, is that interest covered by this allowance?
Investors do not pay any personal tax on income or gains, but ISAs do pay unrecoverable tax on income from stocks and shares received by the ISA managers.
Ahead of the changes to the ISA allowance which are now less than two months away (6th April) we take a look at the changes to the personal savings allowance that came into play this time last year, and examine whether or not it’s still a good idea to invest into an ISA.
As of 6th April 2017, savers in the UK will be able to put away £20,000 a year in an ISA; an increase of £4,760 from £15,240 the current upper limit. The change was introduced during last year’s budget when the then Chancellor of the Exchequer George Osborne announced the increase "to further help savers at a time of unprecedentedly low interest rates".
Just shy of two years ago, July 2014, the ISA limit was increased by a similar amount, up from £11,880 to £15,000. The rules were also made much more flexible, allowing savers to put the entire allowance into a stocks and shares ISA, half into a cash ISA, or a mix of both.
The previous rules restricted the amount of money that could be held in the cash ISA.
Other changes relaxed the rules around switching ISAs. Before, you could only move money from cash into the stocks and shares version but not vice versa; this rule was abolished and savers are now able to transfer previous years’ funds from stocks and shares ISAs into cash if they so wish.
More good news for potential investors with the surprise announcement of a new Lifetime ISA (also being introduced in April of this year) that gives a state bonus to under-40s saving to buy a home or for retirement.
The other big news to shake up the savings market in the UK last year was the changes in the personal allowance-now basic-rate taxpayers will be able to earn £1,000 in savings interest outside an ISA before paying any tax, and higher-rate payers will be able to earn £500.
This really is the biggest change in personal allowances that our generation has seen - Since April 2016, your savings interest has been paid to you tax-free, and 95% of UK adults no longer pay tax on any saving.
In the past, for every £100 interest earned, basic-rate taxpayers lost £20 in tax, higher rate £40. Yet now the new personal savings allowance (PSA) means every basic-rate taxpayer can earn £1,000 interest without paying tax on it (higher rate £500), equivalent to the interest on £100,000 in the top easy-access savings account.
So how much is the personal savings allowance?
Well it all depends on how much you earn and what resulting rate of tax you pay:
- Basic-rate (20%) taxpayers earning up to £43,000 – will be able to earn £1,000 interest with no tax (so a max tax saving of £200 compared with before).
- Higher-rate (40%) taxpayers earning between £43,001 and £150,000 – will be able to earn £500 interest with no tax (so a max tax saving of £200 compared with before).
- Additional-rate (45%) taxpayers earning over £150,000: £0 – they do not get an allowance.
The treasury have estimated that this change will take 95% of savers out of paying any tax on their savings.
Is it just interest on savings accounts that counts?
No, interest you earn from any form of account such as bank accounts, savings accounts, credit union accounts, building societies, corporate bonds, government bonds and gilts is covered, including interest earned in other currencies held in UK based savings.
Peer-to-peer lending interest is also covered, but dividend income from shares or funds is not included in the allowance. It also includes interest distributions (but not dividend distributions) from authorised unit trusts, open-ended investment companies and investment trusts and most types of purchased life annuity payments.
If I'm already saving into a tax-free account, is that interest covered by this allowance?
No. Interest that is already tax-free isn't included – so this includes ISA interest and Premium Bond 'winnings'. Interest from these will still be paid tax-free, it just won't count toward your PSA limit. So, if you get £500 in ISA interest, and you're a basic-rate taxpayer, you'll still have £1,000 of PSA to cover other interest.
Can my savings within the personal savings allowance push me into a higher income tax band?
Yes, although the tricky question comes if your non-savings income, which would generally be income from work (whether employed or self-employed), is below the higher-rate threshold but your savings income would take you above it.
So do you get the £1,000 for basic-rate taxpayers or do you get the £500 for higher-rate taxpayers?
To work this out you must first add up your income from work and income from earned savings interest to get your total income. If that total income puts you in the higher-rate band (over £43,000) then you are a higher-rate taxpayer and you only get the £500 of personal savings allowance (similarly for those at the additional-rate threshold – you wouldn't get the personal savings allowance at all).
To best illustrate this point, it’s useful to run through an example:
The higher rate of tax starts on income above £43,000 (in the 2016/17 tax year). You earn £42,999 plus have £1,000 in savings interest. As your total income including interest is above the higher-rate threshold you'll only get the £500 personal savings allowance. So, £500 of your interest would be tax-free, while the remaining £500 would be taxed at the higher rate.
Is there any point in saving in an ISA then?
Even after all these huge changes, ISAs still do have their advantages. For most people the personal savings allowance will mean all of their savings are tax-free, and therefore when choosing a product, the basic question is simply "What’s going to pay me the highest rate of return?'"
And for most people with under £20,000 of total savings, ISAs won’t be that great. However, for the majority of Cadence’s clients, those who in the main are bigger savers and higher earners, an ISA is still a winner due to the new Personal Savings Allowance rules.
The most important thing to note is that ISA interest doesn’t count towards your PSA, so you are able to earn it tax free with your full £1,000 (or £500) PSA in addition. Therefore higher earners in the top rate taxpaying bracket or bigger savers who’ve used up their PSA, there are big tax advantages of savings into an ISA even before considering the potential fund growth.
A few examples below highlight this:
- Basic- rate taxpayers over the PSA limit – For every £100 interest they earn in normal savings, they only get £80, whereas in an ISA they will get the entire £100. Therefore normal savings rate would need to be 25% higher to beat an ISA.
- Higher-rate taxpayers over the PSA limit – For every £100 interest they earn in normal savings, they only get £60, whereas in an ISA they would get the entire £100. Therefore normal savings rate would need to be 66% higher to beat an ISA.
- Top- rate taxpayers – For every £100 interest they earn in normal savings, they only get £55, whereas in an ISA they would get the entire £100. Therefore normal savings rate would need to be a whopping 82% higher to beat an ISA.
So for higher earners, ISAs can have a huge advantage even with lower rates of return. It’s also worth remembering that while £1,000 a year interest seems a lot now with the current pitiful interest rates, if these rise then more people will be required to pay tax. So saving into an ISA now could protect you from future tax.
It is worth noting though that there isn't a 'personal investment allowance', so if you want to invest you should use your stocks & shares ISA allowance ahead of your cash allowance this should provide a much greater gain for you. This of course is very much dependent on the type of stocks and shares you decide to invest in and ultimately the advice that is given. Cadence will work with you to determine which sorts of funds would be suitable given your investment objectives, time horizons and specific goals and generally speaking our philosophy is to adapt a more passive investment approach to fund management rather than an actively managed style. So whether you are a working professional looking to put away £400 a month into the most tax efficient vehicle for general savings or if you’re a professional footballer who has just received a £400,000 performance bonus, we adopt a similar approach to our fund management.
As we have seen, for higher earners the new rules can make saving into an ISA even more attractive and you may well be looking at accumulating seven figures within the next two decades.
By investing in a stocks & shares ISA every year for the next 20 years could make you a millionaire. This is with average returns of between 5% and 6% per annum and maximising the £20,000 allowance each year, on a regular monthly savings plan – £1,666 per month.
With the size of the ISA allowance (£15,240 and rising to £20,000 from April 6) it means that many people will not hit the limit in any tax year. It would be a good idea to start thinking about making regular contributions throughout the tax year. Drip-feeding your savings into a stocks and shares ISA month by month is a good discipline, reduces the risk of investing at a peak in the market and leads to smoother returns. Investors who are nervous about putting money into the stock market at these levels can always park it in a share ISA, but not invest it until a later date, meaning you can then take advantage of any dips in the market.
In ten years’ time the FTSE 100 index will almost certainly be considerably higher than it is today and the recent market fluctuations will appear as a mere blip on the charts. For example, if you had invested £15,000 in the FTSE all-share index 20 years ago you would now have a sum of £52,965. If, however, you had invested the same sum in a typical UK savings account you would now be left with a paltry £19,916. That’s a difference of £33,049 — too big for any investor to ignore.
Although this sounds tempting, many people are put off stocks and shares by the chore of selecting suitable funds. The answer may be to use a financial adviser who can help you determine which funds will best suit your own risk appetite. Cadence will often offer a suggested starter portfolio, which first-time investors can adopt until they gain confidence to make their own selections. As previously mentioned these would usually be made up of a number of passive funds reflecting your own personal risk appetite which is usually congruent to your current life cycle stage.
In short, there has never been a better time to max out your ISA allowance, especially a stocks & shares ISA provided you seek the correct guidance.
The value of the investment and the income they produce can go down as well as up and you may not get back as much as you put in.