Cash ISA savers risk putting convenience before effective tax planning.
With the tax year end fast approaching the article below provides useful reading when considering the use of ISA allowances to maximise the full tax and investment benefits provided by the increased £15,000 allowance. For further information please visit my website.
Savers searching for attractive Cash ISA deals in the run-up to the end of the tax year look set to be disappointed once again. In the two years since the introduction of the government-backed Funding for Lending Scheme, savers have seen deposit interest rates more than halved while the headline rate has not changed.1 Banks and building societies, with access to this cheaper source of funding, no longer need to compete to attract savers’ deposit money. Consequently, the average instant access Cash ISA rate has fallen to a new low of 1.05%. 2
But old habits die hard for British savers, despite the low rate of returns in recent years. A new BlackRock survey has revealed the extent of the emotional attachment among savers to cash – and the comfort they draw from holding this asset class.3 BlackRock found that more than two-thirds of people surveyed held their investments in cash, although they acknowledged that they should only hold half of this amount. Worryingly, many savers are overlooking the erosive impact of inflation on their savings, with one in seven surveyed under the impression that cash never loses its value. (However, the recent fall in inflation has provided some respite for savers.)
The use of ISA allowances to bolster cash reserves means that many people are foregoing the full tax and investment benefits provided by the increased £15,000 allowance. BlackRock found that nearly a third of people planned to hold even more cash in their ISA pot as a result of the changes. It’s little wonder that, in spite of the dilemma faced by savers, Cash ISAs still accounted for more than three-quarters of subscriptions in the last tax year and more than half of the total £448 billion invested in ISAs since they were introduced in 1999. 4
A separate survey conducted by market researchers Mintel last year also revealed the tendency of many savers to take the easy option when choosing their Cash ISA provider, rather than seek out the best rate; while 39% told Mintel that they chose their provider based on the best rate available, just under a third simply opted to go back to their existing provider. 5
Mintel’s research also revealed that less than two-fifths of ISA holders said they were investing to take advantage of the tax benefits; rather than save in an ISA to reduce tax payments, most people use their allowance instead to save for a holiday, to fund their retirement or, simply, to achieve the sense of security that a savings pot can provide. Unsurprisingly, BlackRock’s survey found that 39% of people said the reason they held so much in cash was because it made them feel safe.
Chris Ralph, Chief Investment Officer for St. James’s Place, points out that ISAs offer long-term investors far more than just a place to accumulate cash. “Certainly, we have always maintained that cash is the right home for money that you might need in the short term,” explains Ralph. “However, we believe that the real value of your ISA allowance is in the opportunity it provides to accumulate both long-term income and capital gains that are free from any further tax liability – something that a Cash ISA simply cannot do.”
Of course, the flexibility of ISAs makes them ideal to help fund retirement and BlackRock’s research revealed that half of retirees are already using an ISA to do so. But worryingly, almost two-thirds of this group have only used Cash ISAs to date. Even among those aged between 55 and 64, who should be focusing on growing their retirement pot, BlackRock found that around seven out-out-of-ten often hold all of their ISA wealth in cash.
With the government’s radical changes to Britain’s pension rules due to be introduced in April, the very real concern is that many savers may opt for the perceived safety of cash, if the decisions they face at retirement are too complex. Cash, however, is among the least efficient means of generating income in retirement.
The value of an ISA with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than you invested. An investment in a Stocks and Shares ISA will not provide the same security of capital associated with a Cash ISA.
The favourable tax treatment of ISAs may not be maintained in the future and is subject to changes in legislation.
1 savingschampion.co.uk, November 2014
2 Bank of England, January 2015
3 BlackRock Investor Pulse Survey, February 2015
4 HMRC, September 2014
5 Mintel survey, September 2014
For more Tax year-end articles, please visit my website.