The vision for the European Union’s new Savings and Investment Union is flexible investment accounts with a focus on a simple, easy-to-understand structure, open to all rather than just wealthier people, with no time nor geographic limits on what you can invest in or for how long.
Ireland’s Minister for Finance, Simon Harris, is examining options for an account of this type in Ireland – currently pencilled in for unveiling in this October’s budget – to try to persuade people who have up to €170 billion on deposit in Ireland’s banks earning little or no interest to invest this in the wider Irish and EU economy.
Initially, he clearly flagged a preference for the Swedish Investeringssparkonto (ISK), the structure of which we examined a few weeks ago. Since then, under fairly intense lobbying, he appears to have pulled back somewhat on that, with Britain’s Individual Savings Account (ISA) model coming more into consideration.
So how do ISAs work?
ISAs have been available to people in the UK for more than a quarter of a century, having been introduced in 1999, offering tax advantages to encourage saving and investment, so they are, at this stage, a tried-and-tested model.
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There has been tinkering with the rules along the way in the light of experience, most recently in last year’s UK budget, that will reduce access to cash ISAs for people under the age of 65 from next year. They are also looking at introducing a specific ISA product for first-time buyers.
But, for now, let’s focus on the scheme as it operates today.
Are all ISAs the same?
No, they’re not. There are five different classes of ISA, each with its own rules and focus, although many of the rules do operate across more than one class of ISA.
First, you have a cash ISA, which is pretty much the same thing as a bank deposit. The money can be held in any class of savings account – instant access, term or notice-period ones. The advantage over bank saving outside the ISA structure is that the interest you earn is free of tax.
This really is an option only for people looking at very low-risk savings options. The cash ISA comes with the standard deposit guarantee – which in the UK covers savings with any institution of up to £120,000 (just shy of €138,000) and there is obviously clarity over how much of a return you can expect, given the advertised interest rate.
However, the whole impetus in the Irish model is expected to be to persuade people to move away from basic bank deposits which, over time, offer lower returns than other forms of investment.
Next are stocks and shares ISAs. These are investment accounts through which you invest in individual shares, bonds and wider funds. Again, a signal attraction is that the investment is tax free.
These are the ISAs most likely to be examined by Harris and his department team. They are targeted at savers who are willing to consider longer-term investments in search of better returns than they can expect with bank deposits.
There is no mandatory lock-in period so it is not as though people are denied access to their cash if their circumstances change but the logic of this style of investment is that you aim to keep it there for the medium or long term.
In part that is because market volatility means the value of your fund can go up and down over time – sometimes wildly over the short term. Staying invested for the longer term smooths out the impact of these cycles.
You also need your investment growth to cover the fees that are levied by providers for such investments and are obviously not a feature of deposit accounts.
Ratcheting up the risk profile, there is an Innovative Finance ISA. This allows your money to be invested in all sorts of exotic things, such as cryptoasset exchange traded notes, peer-to-peer loans (where your money is lent to people or businesses without using a bank), crowdfunding debentures (where your investment is buying company debt) and funds with a notice or redemption period that will not qualify for inclusion in a stocks-and-shares ISA.
The scale of potential gains here is higher – but that is because of the risk involved. There is a much greater chance that some or all of your investment could be lost. If you do make gains, they are tax free but there are no offsets for losses.
This type of investment would really only be a realistic option for very experienced investors or those with substantial assets.
A Lifetime ISA is a more tightly controlled product with the added attraction of a 25 per cent government bonus that comes with it – very much like the old Special Savings Incentive Accounts (SSIA) model under Charlie McCreevy for those old enough to remember.
It was one of the changes to the ISA regime over time, having been introduced only in 2017. It is available only to people aged between 18 and 39 although, once enrolled, you can continue to save up to the age of 50, and the bonus is dependent on the funds being used either to buy a first home or for retirement.
There is an upper annual investment limit of just £4,000 on a lifetime ISA, well below the general ISA investment cap, with the potential for a government bonus of up to £1,000. A person can hold up to two Lifetime ISAs – one in cash and the other in stocks and shares – but they can only contribute to one of them in each tax year.
There’s a limit on the value of the property it can be put toward as a deposit too – £450,000, a figure that has been unchanged over the past decade. If the home you are buying is more expensive, you face a financial penalty on withdrawal of funds from the ISA.
Unless you are using the invested funds to buy a home, you cannot access the proceeds until you turn 60.
The UK has already announced that, from 2028, the Lifetime ISA will be replaced with a product more focused on house purchase with no retirement savings option, something the Government here might well factor into its thinking.
Finally, there is a Junior ISA, a product aimed squarely at establishing a savings pot for children.
Parent or guardians can put away up to £9,000 a year into savings or investments for a child under the age of 18, without any tax implications. While the adult manages the account, they cannot use the funds, which are destined solely for the child but which they cannot access until they turn 18.
Who can open an ISA?
You must be over 18 and a British tax resident to open an ISA. There are further limits for certain types of ISA, such as Junior ISAs and Lifetime ISAs.
How much can you save?
The general annual limit is £20,000, although, as we have seen with the Lifetime ISA (£4,000) and the Junior ISA (£9,000), lower limits can apply to certain products.
That brings in some variety that might work against the very simple, easy-to-understand structure the Government is aiming for here.
If you don’t invest or save the full £20,000 in one year, that is it. You start the next year with a new £20,000 threshold but cannot carry over anything unused from previous years.
The UK is, from next year, reducing the amount people under the age of €65,000 can invest in a cash ISA to £12,000 from the current £20,000 limit, largely to reflect the understanding that investing solely in bank deposits was never what the ISA regime was designed to do.
That decision is also likely to resonate with the Department of Finance as it examines options for the Irish personal investment account products in advance of the budget.
Must the money all be invested in the one product?
No, you can spread your £20,000 threshold across one or more ISAs. So, for instance, you could put £4,000 into a Lifetime ISA, assuming you meet the age qualification, £12,000 into a stock-and-shares ISA and the balance, £4,000, into a cash ISA if you so chose.
Or you could spread the same £20,000 across four or five different stocks-and-shares ISAs targeting different types of market investment. There is no limit on the number of cash or stock/share ISAs you can hold, but you are limited to just two Lifetime ISAs as explained above.
What happens if I’m not happy with an ISA product?
Given the annual cap on contributions, people might be understandably concerned at what would happen if the fund you are invested in is underperforming and you want to consider other options.
You can transfer from one ISA product to another, as long as the new product accommodates the type of investments you hold in the original one. So, for instance, you could not switch funds invested in some forms of Innovative Finance ISA into other types of ISA.
Funds transferred do not count towards your annual investment limit.
To transfer, you contact the ISA provider whose product you want to transfer to and they will provide the necessary paperwork. The process generally takes a month to complete – or just over two weeks for a cash ISA.
What about taxes?
This is where ISAs come into their own. While the money you invest will come from already taxed income – assuming you meet the threshold to pay income tax – there is no tax on the profits or interest that your invested money makes. So, in a cash ISA, all interest is tax free. In other ISAs, where you can be invested in markets or funds, there is no tax either on the investment gain or on any dividends that you may receive from direct investments in shares.
You mentioned SSIAs. Do these have similar time limits?
The SSIAs, which were introduced back in 2001, were time-limited accounts. They matured after five years at which point savers could withdraw the funds or roll the savings over into any other savings or investment product already on the market.
That is not the case with ISAs. There is no time limit on how long the money can stay within the ISA structure, enjoying its tax-free status on any growth.
How does the ISA model differ from Swedish ISK accounts?
In the UK, ISA accounts are entirely tax free but there is a limit on how much you can invest. In Sweden, there is technically no limit on how much you can put into an ISK but anything above 300,000 Swedish kronor (around €27,750) in one year will still be taxed as income.
In addition, the fund is taxed each year, whether it makes any gains or not.
You can contact us at OnTheMoney@irishtimes.com with personal finance questions you would like to see us address. If you missed last week’s newsletter, you can read it here.
