ISA Allowances 2011/12 Tax Year

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At midnight tonight the new 2011/12 tax year starts!

ISA allowances are increasing from £10,200 to £10,680.

Of this £10,680, up to £5,340 can be invested in a Cash ISA, and any unused allowance between the amount you put into a Cash ISA and the overall allowance of £10,680 can be invested in a Stocks and Shares ISA.

For example, invest £2,000 in a Cash ISA from midnight tonight and you can still invest up to £8,680 into a Stocks and Shares ISA.

If you can afford to invest on a monthly basis, to benefit from pound cost averaging, the maximum each month (assuming 12 payments) is £890.

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Concerned about Stock Markets? ISA Cash Park

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How to Park your Money in an ISA

Many people are concerned about the current state of UK and world stock markets, together with other investment asset classes, yet they would still like to utilise their ISA allowance for the future tax-efficient benefits which an ISA investment can provide.

There is a solution.

At present it is possible to invest up to £7,200 into a Stocks and Shares ISA, with up to £3,600 of this limit being allowed to be held in a Cash ISA – with the balance available to be placed into a Stocks and Shares ISA.

For example, if you invested £2,000 into a Cash ISA in the current tax year, you would still be able to invest £5,200 into a Stocks and Shares ISA.

Following the announcement in the Budget today (22nd April 2009) by Chancellor of the Exchequer, Alistair Darling, the ISA limit will increase from £7,200 per year to £10,200 per year total (which can include up to £5,100 in a Cash ISA) for those aged over 50 on 6th October 2009, and with the remainder of the eligible population being able to invest £10,200 from the start of the next tax-year on 6th April 2010.

Many people would like to invest their full allowance within an ISA but are concerned with continuing stock market volatility and econnomic uncertainty over the short to medium-term.

Many ISA providers are acutely aware of the concerns which investors have at present in placing their money into equity and other asset classes. They are therefore offering a “cash holding” or “cash parking” facility whereby an investor can place money into an ISA today, thereby securing their entitlement to their ISA allowance and deferring their investment decision to a later date when they may feel more confident about economic conditions and stock market outlook.

The money held in the “cash park” of a Stocks and Shares ISA may receive interest (see below regarding tax position).

Important Points to Note

Any money held as “cash” within an ISA is a temporary position as the Inland Revenue expect you to ultimately invest these funds into funds. The cash fund may receive interest whilst the funds are held as cash – this interest will be subject to 20% taxation – which is in line with the tax position on interest received from a bank/deposit account.

The main difference here though is that this tax is not reclaimable by a non-taxpayer.

No Cash in a Stocks and Shares ISA

It is also important to remember that regulations do not currently allow a “cash” fund to be held under a Stocks and Shares ISA – therefore any decision to invest cash into this type of ISA must ultimately be made with a view to investing in mutual funds at a later date.

Conclusion

This is a useful facility for those people wishing to invest in an ISA but not wishing to commit their funds to a fund carrying risk in the current economic and investment climate.

It’s not how much you save, but how long

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Long Term Savings – the need to start early

Saving for income in retirement can be a daunting thought for most people – the problem they face is that they simply don’t know how much they need to save between now and retirement.

In this article we consider the time value of money, and in particular, the benefits to be enjoyed from “compound growth”. In later articles we consider just how you go about working out how much you need to invest to plan for your own retirement income.

The Rule of 72

In the article “The Rule of 72 – the Time Value of Money” we discussed a simple technique for calculating how your money grows over time whereby dividing the rate of growth you are enjoying on your money into 72 shows the number of years it takes for your money to double in value.

For example – if you were lucky enough to receive 6% annual interest on your money in a savings account then this would double in value every 12 years (72/6=12).

Compound Interest

The principle of compound interest is simply one of “money makes money”. An example of this would be investing £100 in a savings account at 10% interest – after one year your money would have grown to £110 – after two years, £121 – you have earned an extra £1 interest in year two as not only have you earned 10% on your original investment of £100 but you have also earned 10% interest on the £10 interest you made in year one and this continues for as long as you leave that money invested.

Over time, as the proportion of “interest earned” grows then the rate at which your overall investment grows also increases – it’s like a snowball effect – when you roll a small snowball down a hill at first it grows slowly – the more it rolls, the more snow it picks up on each rotation and the faster it moves…….

The following chart shows how £500 per month, enjoying a simple return of 5% per annum, grows over a 30 year period –

Demonstrating compound interest on regular savings over time

The above chart shows that in the earlier years the rate of growth on the funds invested is relatively low, and as the benefits of compound growth accumulate over time the curve of the graph becomes steeper as each and every £1 of interest earned subsequently earns its own interest!

It’s not how much you save, but how long….

The principle of compound interest therefore brings us nicely into the subject of pension planning, saving for retirement or any other form of long-term saving.

For the sake of this example we will consider that you wish to retire at age 60 and you are now aged 30.

You have calculated that to provide income in retirement of £20,000 per year, ignoring inflation for the time being, and assuming a return of 5% after charges for both the growth on your money being invested BEFORE retirement and for the annuity income you receive AFTER retirement, that to provide £20,000 per annum you need a fund of £400,000 (£20,000 per annum divided by 0.05).

So to achieve this income goal you need to build up a fund between now and retirement of £400,000. Logic says that we simply divide the fund needed between the number of years to retirement and this tells us how much we need to save each year – in this example £400,000 over 30 years requires a saving of £13,333.33 per year (£1,111.11 per month)

This however doesn’t take into account the growth that you would enjoy on each contribution being paid into the investment vehicle – the contribution made in month 1 would have the longest time to grow – 29 years and 11 months, the contribution made in month 2 – 29 years and 10 months and so on…….

Compound Growth and Regular Savings

Saving on a regular basis into an asset-backed investment, such as a pension fund, or a unit trust held under an ISA umbrella, can benefit from “pound cost averaging”. In a volatile stock market, such as the one we are currently in, investing on a regular monthly basis means that you effectively have 12 chances each year to invest some of your money into the stock market on a day when the market is lower than on other days. The benefit of this is that it brings down the average cost of the units you hold, and ultimately leads to a larger potential profit at the end.

In our example above we calculated the monthly contribution required to build a fund of £400,000 assuming no growth

If we add in say net annual growth of 5% after charges (which should be achievable over the medium to long term) then the monthly investment actually falls to £480.62 per month.

If the rate of growth increases to say 6% per year, the monthly investment falls to £398.20 per month.

If the rate of growth again increases to say 9%, the monthly investment required to hit £400,000 falls to £218.49.

The Cost of Delay

Above we calculated that £480.62 invested at 5% net per annum will grow to £400,000 over a 30 year period. If we reduce the term to 29 years, then to achieve the same fund value, the monthly investment needs to be £512.77 per month – an additional monthly investment of £32.15 or an additional total investment of £11,188.20 over the life of the investment. This shows the cost of delay.

So by waiting one year, an additional £32.15 per month needs to be invested, each and every month for the whole 29 year period, to provide the same £400,000 fund at age 60.

If the individual were to delay their regular savings by 2 years then a monthly investment of £547.63 would be needed – delay by just 5 years and the monthly contribution rises to £671.69 which is probably beyond the means of most families with average income and outgoings.

Starting Early

We have now calculated that the regular saving to build a fund of £400,000 over 30 years, at 5% net return per annum, would be £480.62 per month – but what if you were to start earlier?

If you had the foresight to have started last year, and therefore have a period of 31 years over which to make this investment then this monthly investment would fall to £450.90 – start 5 years earlier and the monthly investment would need to be £352.08……………….

Conclusion

In conclusion then it is vitally important that you start saving as soon as possible for retirement income – whether that be through a personal pension, stocks and shares ISA, a deposit account…….

Start as soon as possible!

Ask yourself this question – how many more paydays until retirement? – 30 years – another 360 payslips – it’s later than you think!

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ISA’s – Individual Savings Accounts

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As we approach the end of another tax year on 5th April many will be mindful of the need to fully utilise their ISA allowance –  you may have heard people mention ISA’s but you’re not quite sure what they’re all about – something tells you they’re risky!

What is an ISA?

An ISA (Individual Savings Account) is a form of tax-efficient savings and investment product. Following recent changes in legislation there are now two types of ISA with which we are concerned: –

Cash ISA

A Cash ISA is a savings account, normally through a bank or building society, as well as National Savings, which effectively pays interest tax-free. Cash ISA’s are available to anyone over the age of 16.

With a normal savings/deposit account tax is deducted from gross interest and the saver receives the net amount – the current rate of tax on interest is 20%. There is no additional tax to pay for a basic-rate tax payer; a higher rate tax payer will pay an additional 20%.

With a Cash ISA though, anyone, regardless of their tax position, can invest up to £3,600 in the current tax-year to benefit from tax-free interest. The government place a limit on the amount you can invest in your ISA due to the tax-efficient nature of the investment.

Non-taxpayers – did you know?

If you are a non-taxpayer you can register to receive your interest on your bank and building society accounts gross – you need to fill in form R85 – getting your interest without tax taken off – simply complete the form for each account/institution and pass to them to amend their records.

Where can I find the best rate?

League tables are generally published in the better quality newspapers, or alternatively you can search on line at a comparison site, such as moneyfacts or any other cash ISA comparison site.

Are they instant access?

Generally, yes, but a number of products offer a higher rate of interest, or even a fixed rate, in exchange for you not making any or many withdrawals – you can normally access your money though with an interest penalty applying. Make sure you check the terms and conditions for any cash ISA you choose to invest in.

Stocks and Shares ISA’s

These are for the more adventurous investor. The overall allowance for investing in ISA’s is currently £7,200 per person per tax year. Any investment made into a cash ISA in the current tax year will count against this allowance. For example – say you have put £2,000 into a cash ISA, you are therefore able to invest an additional £5,200 into a stocks and shares ISA.

Lump Sum or Regular Contribution?

It is possible to set up both single premium and regular monthly ISA’s. If you go for the regular option this would equate to £600 per month if you spread your allowance across the full tax year.

Where can I invest?

There is an enormous choice of places to invest your Stocks and Shares ISA allowance – you could choose to invest direct into the shares of a few companies, or you could reduce the risk slightly by investing in “pooled fund(s)”.

By investing in a pooled fund, the investment manager pools your money together with the money of all the other investors in the fund, and invests the money by buying and selling shares and other assets in line with their management style. The benefit of this is that the investment manager and their team can use their investment expertise and research to invest in companies they believe are going to provide an above average return going forwards. The second benefit is that your money, through a pooled fund, will be spread over a far wider range of companies – therefore reducing the risk to your money.

You can invest either direct with a fund manager or through a “fund supermarket” – the latter option will give you access to a large choice of different funds from a wide choice of investment managers. Fund supermarkets can sometime negotiate discounts on the charges and pass these savings on to their clients.

Charges?

Yes – normally with a pooled investment there will typically be an “initial charge” which can be from 0% upwards with initial charges typically being in the region of 5%. There might also be an “annual management charge” – this covers the ongoing costs of running the investment fund. These AMC’s are typically in the region of 1% – 2% per annum – check the charges on any fund you choose to invest in prior to committing your funds.

Is there a risk?

Your money is being invested in a fund(s) which the manager will invest in a range of stocks and shares of companies, corporate bonds, gilts etc depending on the investment strategy and type of fund you choose.

I am sure you will be aware of the recent falls in world stock markets. Any fall in stock markets will be reflected in the value of your investment – so yes, you could lose some, or even possibly, all of your money. For this reason you need to ask yourself whether you are prepared to take risks with this money – and also to give consideration to the length of time you are willing to invest for – a minimum of 5 years, and preferably 10 years would be a good answer here!

Why invest in ISA’s?

The benefit of ISA’s is that they grow in a very tax-efficient manner and any income you receive from your ISA is also tax-free. In addition to this it is also possible to access the money invested if the need should arise.

Many people use their ISA allowance to save and invest for longer term goals – such as a house move in 5 or 10 years time, or to provide income in retirement, to supplement other pension income – some people prefer to invest in ISA’s than in personal pension plans due to the fact that they can access their ISA money – although that can be too much of a temptation to some people!

Summary

There are two different types of ISA and you can invest up to £7,200 in the current tax year. Once we pass 5th April you will lost your ISA allowance for the current tax year – once gone it is lost forever.

Risk Warning

With a stocks and shares ISA there is risk to your capital – the value of your investment is not guaranteed, the value of the investment, and the income from it, can fall as well as rise. You could lose some or all of your money.

If you have any comments to make on ISA’s please add them below –