Smash open your Isa’s full potential

Tom Welsh
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INDIVIDUAL savings accounts (Isas) are a success story of financial marketing. Most are aware of them, many use them, and a great number understand their tax benefits. As the tax year ends on 5 April, everyone should now ensure they take full advantage.

Despite Isas piercing the public consciousness, some investors don’t make the most of them. Keith Evins, head of UK marketing at JP Morgan Asset Management, says misconceptions concern Isa providers, and motivate “a strong emphasis on education and guidance” by providers.

Most errors stem from the idea that Isas are products in themselves, when in fact they’re just tax wrappers. Others are a misunderstanding of varying kinds of Isas and their flexibility. Many people also subject their Isas to a degree of neglect. Central to this is often a belief that Isas only offer tax benefits, with investors forgetting that they can be vehicles for growth as well as shelters for capital.

Isas should be the cornerstone of any investment strategy because they can combine tax benefits with flexibility. There is still time for investors to shelter up to £10,680 from taxation and, once inside the Isa wrapper, that money isn’t liable for tax on interest, on dividends or on capital gains.

According to Evins, the best strategy to consistently use your full Isa contribution limit is through steady monthly contributions. This encourages habitual saving as well as, if invested in an equity Isa, helping “to smooth out the ups and downs of the market” if the investor is nervous of making a lump contribution at the top of the market.

Isas can be more diverse than just tax-protected savings accounts. Cash Isas attract a high proportion of savings, but contributions can be placed into a diverse range of investment vehicles. Cash isn’t necessarily the best way to grow the value of your contributions.

Cash Isas are often perceived as the risk-free option. Although they offer capital protection, this benefit isn’t necessarily exclusive. Catherine Penney, of Barclays Stockbrokers, notes that low-risk products can be bought through equity Isas.

The choice between cash and equity should be decided by the purpose and the time frame of the investment. Penney says instant access cash Isas are for “emergency funds.” If your time frame is longer, and you want better growth, equity Isas or fixed term cash Isas may be more appropriate. Stocks and shares Isas also allow a larger contribution – the full £10,680 in the tax year 2011-12, compared to £5,340 for cash Isas.

Cash Isas carry a risk based on historically low rates of return. Nick Blake, head of retail at Vanguard Asset Management UK, warns that “return on interest may be below the rate of inflation, thus eroding purchasing power over time.”

Blake says that “stocks and bonds typically, over longer periods, outperform cash deposits and provide better protection against inflation.” Unless you require easy, quick access, you should consider how inflation might put the purchasing power of your core contribution at risk.

Isa contribution limits are refreshed every year so the long-term cap on your investment is only limited by financial circumstances and lifespan. But Isa investments shouldn’t be made and forgotten about. “In tough economic times, it’s even more crucial to review all of your existing Isas,” says Penney.

Evins says care should also be taken with cash Isas. The money “isn’t locked up forever” and there is a benefit in watching market competition, and moving money when possible.

With instant access cash Isas, bonus rates offered as enticements can end, and investors need to move their money once they expire. Similarly, with fixed rate cash Isas, you should consider how long you want to lock away your investment, and whether better returns could be gained from an equity product.

The cash Isa market is competitive and consumers should take advantage of this. Providers offer attractive initial rates because they want you to invest with them, and this initial attractiveness wears off because providers rely on a degree of torpor by investors. To make the most of your Isa, don’t conform to their low expectations.