Is there any point in an Isa? Decision time as the deadline looms

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In the final hour of the tax year last April, a stocks and shares Isa was opened or topped up every seven seconds on the systems of Britain’s largest retail investment company, Hargreaves Lansdown. There is nothing to focus minds more than a deadline, and the approaching end of the tax year on 5 April means people are increasingly looking at whether they should still opt to open an Isa – or lose the tax-free perks attached.

But with interest rates now so low, is there any point when it could end up delivering such minor gains?

The deadline approaches

When the tax year ends, so does the opportunity for anyone over 16 to put away £20,000 in an individual savings account for 2020-21.

You don’t have to pay tax on any interest earned on cash, income or capital gains from investments. But when the new tax year clicks in, that £20,000 allowance goes and you cannot get it back.

Many investors will choose between a cash Isa, which acts like a normal savings account, or a stocks and shares Isa (or investment Isa), where money can be put into funds, trusts and individual shares.

Cash Isas have not had a good time of it lately. Coupled with the fact that they can offer lower rates than other savings accounts, low interest rates set by the Bank of England mean there is little to attract savers.

Financial data site Moneyfacts lists the best return on an easy-access Isa as Al Rayan Bank, which gives 0.6%. Meanwhile Goldman Sachs’s Marcus online savings account pays 0.5%.

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Along with this, since the launch of the personal savings allowance (PSA) in 2016, most savers don’t have to pay tax on their savings income. Someone on the basic rate of tax can receive £1,000 of interest and not have to pay tax, while a higher-rate earner has a £500 PSA.

Hargreaves Lansdown analyst Sarah Coles says a higher-rate taxpayer would need more than £70,000 in savings before they started paying any interest on the highest one-year (fixed) rate, and a basic-rate taxpayer more than 150,000.

“It’s one reason why over 1.5 million fewer cash Isas were opened the year after the allowance was introduced,” she says. “At the moment, you can get a better rate on the most competitive easy-access Isa than on its equivalent savings account. However, fixed Isa rates are fractionally lower than on savings accounts, so you can see why savers are questioning whether it’s worth it.”

Will markets make the money?

Savers can be forgiven for being frustrated at the moment as rates continue at rock bottom, and many will be looking towards a stocks and shares Isa to deliver a greater return.

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But with that comes the obvious risk of losing money if shares or funds go down. Laith Khalaf, of investment firm AJ Bell, says that investing on the markets through an Isa is more likely to save tax.

“Stocks and shares Isas protect your dividends from income tax, and while everyone gets £2,000 of dividends tax-free, it won’t take long before a portfolio is breaching that limit.

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“The UK stock market usually yields around 3.5% to 4%, so a UK portfolio, which isn’t in an Isa, can be expected to be vulnerable to income tax once it reaches £50,000 to £60,000,” he says.

“Stocks and shares Isas also protect your profits from capital gains tax, and, while there is currently a fairly generous limit of £12,300 of gains a year which don’t attract CGT, the chancellor is considering cutting this, and raising rates.”

Coles says that savers who are willing to put their money away for up to a decade, and are comfortable that they are not risk-free, should consider putting some money into a stocks and shares Isa. However, she does not write off cash Isas.

“If you’re a basic-rate taxpayer with a couple of thousand pounds in savings, you’re not going to save tax with a cash Isa this year – but it’s not this year you need to worry about, you’re protecting this cash from tax forever, and, over time, all sorts of things could change,” she says.

“There will come a time when savings rates rise, and if they push you over the tax threshold, you’ll be glad your cash was protected. Likewise, your salary could increase and push you into a higher tax bracket, so your savings allowance halves or vanishes overnight.

“Meanwhile, your savings are likely to build up over the years and run a bigger risk of being subject to tax. There’s also the chance that the government decides to cut, or remove, the savings allowance, leaving savers high and dry if they haven’t sheltered their cash from tax.”

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Where to invest

For those who want to get hold of their cash quickly, the best easy-access cash Isa rate is offered by the sharia-compliant Al Rayan Bank, which is paying 0.6%, though this is an expected profit, rather than guaranteed interest.

The same bank offers the best one-year fixed rate at 0.65%, while Gatehouse Bank – which is also sharia-compliant – has the best two-year and three-year fixed rates at 0.8% and 0.9% respectively. Over five years, it offers 1.3%, the top savings deal according to Moneyfacts.

On stocks and shares Isas, the best-performing investment trust fund was JP Morgan China, which would have turned £1,000 into £2,354 after one year. Behind it was the Pacific Horizon Investment Trust, which turned £1,000 into £2,279 over the last year.

After that was the Scottish Mortgage Investment Trust, which went from £1,000 to £2,170, according to figures from Moneyfacts.