Author: Stephen Phillips, 17 May 2007.
Now that the Budget is behind us, we can see that the Chancellor has not just extended the life of
Individual Savings Accounts (ISAs) beyond 2010, but has also outlined some changes to their structure. So how do ISAs compare with pensions now?
Cash ISA Changes
The first point is that, from April 2008, the difference between
cash ISAs and
equity ISAs is to be swept away. This is a good thing because currently, investing just £1 into a cash mini-ISA limits your equity
ISA investment to £4,000.
In bringing the two ISAs together, the rules will simply be that you can invest up to £7,200 into an ISA each year (unless the limits change), of which up to £3,600 can be in cash. There appears to be an element of re-balancing in this because the maximum for cash
investments in an ISA is changing from just over 42% of the annual limit to 50%.
Rebalancing ISAs
Rather more importantly, however, it will from next year be possible to switch money built up in the cash part of an ISA into the equity section (but not vice versa) without this affecting the annual contribution limit. Currently, it would be necessary to realise cash investments and contribute them separately, using up part of the annual ISA allowance in the process.
This partly addresses a criticism raised by many industry experts when ISAs were first launched in 1999, which highlighted the inability to re-balance between cash and equities as being contrary to good asset allocation practice. In an ideal world, movement would be allowed both ways, to allow lifestyle asset planning, to facilitate reduction of risk and volatility as investors get older.
PEPS under the ISA regime
In another innovation, the Chancellor has announced that the predecessors of ISAs, Personal Equity Plans (PEPs), will come within the ISA regime in future, which will make bringing investments together far easier. Currently, only the old cash-based Tax Exempt Special Savings Schemes (TESSAs) could be transferred into the ISA regime on maturity.
ISAs and Pensions Compared
ISAs are sometimes viewed as an alternative to
pensions, because they enjoy similar tax breaks. Both forms of investment can grow free of UK taxes (other than the 10 percent withholding tax on dividends, which has been the subject of so much debate, recently). The major differences are:
- Pensions attract tax relief on contributions up to generous limits - ISAs do not;
- Only 25% of a pension fund can be taken as tax free cash, everything else is taxable income - lump sums and income from ISAs are tax free; and
- Pension funds can only be accessed from age 50 (rising to 55 in 2010) - ISA funds can be taken at any time.
Many would consider that a combination of tax efficient investment vehicles should be used, although there is also a body of opinion that suggests the very accessibility of ISAs make then inappropriate for long term planning; the temptation to take the money before it is needed for retirement planning could prove too strong.
The current rules on ISAs will apply until 5th April 2008 and it is also worthwhile being aware that Child Trust Funds will be capable of being "rolled-over" into an ISA, when they start to mature from 2020.
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