Investment Masterclass: Isa investing is changing

This is an audio transcript of the Money Clinic podcast episode: ‘Investment Masterclass: Isa investing is changing’

Claer Barrett
Good news is rare to come by these days, but for UK savers and investors, there may well be something positive in the pipeline. The government wants to make it more appealing and easier to save in a tax-free way. Millions of us already save and invest tax-free using Isas, or individual savings accounts to spell it out in full. And with interest rates and tax bills rising, Isas have become an even more valuable part of every investor’s portfolio. There’s just one problem: not enough people are aware of their tax-shielding benefits. So grab a notebook because after listening to today’s Money Clinic, you’ll be fully across all the options, and what might change.

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Welcome to Money Clinic, the weekly podcast about personal finance and investing. I’m Claer Barrett, the FT’s consumer editor.

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So let’s start with the good news. The Treasury is looking for ways to simplify Isas and entice more investors to use them. Officials have been meeting business leaders from the financial and investment community, confirming my recent FT front page story that they are open to ideas. But there’s bad news, too. There’s already speculation about the future of the lifetime Isa, a product especially designed for the under-40s, which I know many listeners will hold. We’re going to be discussing why that would be a very bad idea. And another controversial thing: one of the ideas being floated is that Isas could be tweaked to convince savers to buy more shares in UK-listed companies. Well, before I introduce our experts, a reminder as always: if you invest, your capital is at risk. We will be discussing different investment choices and investment strategies on the show today, but this is not intended as an investment recommendation or financial advice. So let’s meet our experts. Joining me in the studio today are first up, Jason Hollands, who is the managing director of Bestinvest, the online investment platform. Jason, in a sentence, tell us what you think is the best thing about Isas.

Jason Hollands
Two things: one, whether you choose to save cash or invest in an Isa, all returns are tax-free. And secondly, they’re really, really flexible. And you can access your money whenever you choose.

Claer Barrett
And a pleasure to welcome back Sarah Coles, head of personal finance at Hargreaves Lansdown. Sarah, the same challenge to you, please.

Sarah Coles
I have to agree with Jason. So yes, it’s the tax savings and the flexibilities. So you can pay in one go, make regular payments, paying whenever you fancy it and you can take the cash whenever you want. They’re kind of a product that really can fit around your life.

Claer Barrett
Yes, much more flexible than pensions, for example. And last but not least, Brian Byrnes, who is head of personal finance at Moneybox, the savings and investment app. Brian, what do you think is the best thing about Isas?

Brian Byrnes
So for me, it’s the positive saving and investing habits that they create. The most recent figures show that 12mn people are subscribing to Isas in some way, shape or form. So that’s 12mn people that are building their financial resilience with a cash Isa, saving for their first home with a lifetime Isa or investing for the future with a stocks and shares Isa. So it’s those habits I think are the most powerful thing about Isas.

Claer Barrett
Well, lots to love about Isas, but we’re not going to assume any knowledge on this investment masterclass. So let’s start with the basics — how people can use Isas to both save and invest tax efficiently. So, Sarah, you’ve got some stats to share with us, too.

Sarah Coles
Yes, all the fun stats. So if I can start with some of the rules, so the basic overall rules, you can save up to £20,000 a year into an Isa, and that’s split across all your Isas. So that’s including things like stocks and shares Isas and also cash Isas. So that’s, like, a pretty generous allowance for most people. Plus, children under the age of 18 also have a junior Isa allowance, and that’s about £9,000 a year, which is generous as well. They’re already hugely popular and this is my nice big figure: overall, that’s almost £750bn held in Isas. So there is, usually, there’s more paid in any one year into cash Isas than in stocks and shares Isas. So another stat is that since the global financial crisis, we’ve paid on average £44bn a year into cash Isas and that’s roughly twice what we pay in stocks and shares Isas. And it’s worth saying that we know that because the rates on cash Isas have gone really high, we know that money’s really flooded into cash Isas this year. So Bank of England stats show a record 9bn saved into cash Isas this April alone.

Claer Barrett
Wow. Well, thank you for all of those. And just to dispel another common myth, lots of people think £20,000 is the limit of what you can hold in an Isa account, but it’s not. That’s just the annual subscription, it’s very generous, as you say. Now, Brian, I’ll bring you in here — assuming no knowledge — can you try and explain the tax benefits of Isas?

Brian Byrnes
Absolutely. So the tax benefits of Isas is that you don’t pay any tax on the growth within the Isa wrapper. So whether that comes from savings interest, investment growth or a government bonus, for example. So let’s say you’re in the fortunate position, you’ve got your 20,000 put into an Isa or you’ve got your 20,000 to save. If you put into a savings account outside of an Isa and you get 5 per cent a year, which isn’t too difficult at the moment given where interest rates are, that’s £1,000 of savings interest across the year, which is really nice. But if it’s outside the Isa, that interest is taxable. Now you might be able to reduce that tax amount with your personal savings allowance, but it is a taxable amount of money. If you did the same thing with a cash Isa, for example, and you get your 5 per cent, that’s £1,000 again of savings interest and that is completely yours to keep. There’s no tax due on that whatsoever. And it’s the same with investment growth with a stocks and shares Isa and it’s the same with the government bonus with the lifetime Isa. It’s all yours to keep rather than having to pay some of it over to the taxman.

Claer Barrett
And the same goes for dividends. If you’ve got an investment Isa, you own shares in a company or a fund pays a dividend to its investors, or share of the profits, if you like, there’s no tax on that. But again, outside of Isas, dividends are taxable and those kinds of taxes have gone up in recent years.

Brian Byrnes
Exactly. Which just makes the Isas even more beneficial under the current taxation regime.

Claer Barrett
Excellent. Now, Jason, as our investment expert, could you tell us a bit more about how people could use stocks and shares Isas to invest?

Jason Hollands
Sure. Yeah. I mean, a stocks and shares Isa can be used to invest either directly in the individual shares of companies, and that’s something that, you know, typically appeals to people who are more confident and they enjoy researching companies. But most people choose to invest through funds, and that would include investment trusts and exchange traded funds. And that’s where your money is pulled together with lots of other people’s and is invested on your behalf across a diverse portfolio of investments, probably a lot more than you would be able to do, doing it directly yourself. And any gains made on the growth in the value of your investments is tax-free. So won’t be subject to capital gains tax. And if your investments generate an income such as dividends from shares or fixed interest from bonds, that’s tax-free too. I think importantly, when you take your money out of an Isa, there’s no tax to pay and you don’t have to disclose your Isas on your tax return. And that’s very different to a pension where there are some nice upfront tax boosts. But when eventually you make withdrawals from your pension when you’re retired, those withdrawals will be potentially subject to income tax at whatever your marginal rate is at the time. So Isas are . . . offer a tax-free returns on the way out, whereas pensions offer a tax boost on the way in, but are taxable on the way out.

Claer Barrett
And as you say, the combination of those things, having the flexibility of Isas and then the tax advantages of pensions when you get a bit older is something that people in retirement love to combine.

Jason Hollands
Absolutely.

Claer Barrett
Well, thanks for explaining that, Jason. And lots of people, certainly because you can take your money out when you want it, see them as a retirement bridge. You could take money out of Isas in your fifties and sixties while you’re waiting to take pension or state pension cash. So we dealt with the basics. But some listeners might be thinking, hang on a minute, these tax benefits, they sound great, but there are a lot of rules and different products and potential choices I could make here. Do we think Isas need to be simplified, as the government is now suggesting? Sarah, start with you.

Sarah Coles
Well, I think I mean, it is worth saying that the Isa range is fantastic and the key here is not to throw the baby out with the bathwater, but there are some things that can be simplified. So if you take, you know, the rule about how many Isas you can pay into each year. So at the moment you can only pay into one Isa of each type, so you can pay into one stocks and shares Isa and one cash Isa. And we just think this is needlessly complicated. So if you have a pension, for example, you page as many pensions as you like each year and say we think the same rules should apply for Isas as long as you stick within sort of the overall limit. And that would just make it a lot easier to open them, to subscribe to them, to transfer them. And it just kind of takes away a level of complexity. I think some of the suggestions that have come up about stocks and shares, mixing stocks and shares Isas with cash Isas, that looks like it’s going to make life quite simple, but actually that creates quite a lot more extra complexity. So if you think, for example, about someone who just offers a cash Isa at the moment, what do we really expect them to do? Do they sort of bolt on a bit of investment, move out, become easier for people who just want a cash Isa and suddenly they’ve got to have lots of communications about investments or will we not force them to bolt on that investment bit and have some of the cash, some of the stocks and shares and some offer a mixture actually, that makes more things more complicated overall?

Claer Barrett
Brian, you were nodding along to some of the points Sarah made there.

Brian Byrnes
Yeah, absolutely. I think some of the devil would be in the detail here. So there’s a lot of rumour and speculation about what is going to come under the umbrella of this Isa simplification package that the chancellor is working on. And some of those will make life simpler for consumers. But some of the things that have been rumoured we think will possibly make things even a little bit more complex than they are today. So I think as we’ve all said today, Isas are absolutely fantastic, they are brilliant, they are working. There are tweaks that can be made here or there to future-proof these, but from our perspective it’s very much kind of evolution rather than revolution.

Claer Barrett
OK, well, up next, Isas are a fantastic tool for UK investors, but should they be used to enhance the advantages of owning shares in UK companies? Now Jason, the FT has reported this as one of the ideas the Treasury has been talking about with industry groups. Could you explain the thinking behind this?

Jason Hollands
Yeah, I mean, there’s been a concern brewing for some time that the UK stock market has steadily become somewhat unloved and the valuations of shares on the UK markets are certainly very cheap compared to similar companies internationally, and that’s leaving them prey to buyers into private equity funds. And likewise, there’s also been an increasing trend for particularly innovative UK companies in areas like tech, choosing to list on the US markets and bypass the UK. And there’s also been a number of cases of where UK-listed companies have upped sticks and moved elsewhere because essentially they can command higher valuations. So the government, part of their thinking is probably to encourage greater investment in UK equities to provide that sort of boost in support to the domestic stock market, all the UK stock market. And one idea that appears to be doing the rounds is to create this additional Isa allowance that would solely be restricted to UK shares.

Claer Barrett
So that would be on top of the £20,000 you get.

Jason Hollands
On top of the 20,000. Yeah.

Claer Barrett
An extra UK bit.

Jason Hollands
Now obviously, while more tax-free allowances are always a good thing in my book, it might not work quite as intended. So firstly such an allowance would only really appeal to people who are already fully using their £20,000 core Isa allowance. Now that’s a relatively small sum of people.

Claer Barrett
Not many listeners.

Jason Hollands
Not many listeners and do remember, I mean, even though it is around about 14 per cent of Isa subscriptions are at the £20,000 mark, do remember that a lot of that will be cash Isas and not all those will be going into investments. But then if you think about it, the people who were able to do the UK-only Isa allowance, having fully used their 20,000 allowance, a very logical thing for them to do would actually to invest less in the UK within their main Isa allowance. So it might not necessarily drive the volume of new flow into UK equities that perhaps is intended. And I think there’s also some technical considerations here. How do you define the types of companies that would be . . . or investments that would be allowed in that UK-only allowance, for example, if the definition was simply any company that was listed on the UK stock market, what would be there to stop someone buying a US or global exchange traded fund, or indeed an investment trust that invests in China or emerging markets or the US? So you’d have to have probably a number of clarifications as to what you could hold in that allowance.

Claer Barrett
Yeah, most certainly. I mean lots of the FTSE 100 may just do maybe up to three-quarters of their revenue-raising outside of the UK, even though they’re listed in London. Now, Sarah, drawing on the research that Hargreaves Lansdown has done, UK investors are already very keen on owning FTSE-listed companies. Tell us a bit more about that.

Sarah Coles
Yes, so there is a huge home bias in the way that we invest in our Isa. So we estimate that around £147.5bn is already invested in, so that’s UK shares. It also includes bonds and collective investments and that’s in stocks and shares Isas. And that’s actually quite conservative estimates because it only includes those things that solely invest in the UK. If you think about that, that’s a 37 per cent weighting towards the UK, which, given the percentage that UK companies make up of the worldwide total, is quite a heavy weighting. And it’s even more striking when you look at shares. So in the past year, 80 per cent of shares traded on the (inaudible) platform, they were UK equities. So technically, you know, you’re talking about this sort of trying to encourage investment in the UK. You don’t really need a whole new Isa allowance, you could just increase the overall allowance and that would automatically increase that sort of investment into the UK. So it’s already very popular and there is a really easy way of sort of cracking this particular nut rather than going out and inventing a whole new type of Isa.

Claer Barrett
Mmm. Well, Jason, another criticism if this strategy were to be implemented is whether people should invest more in UK equities right now. As Sarah said, there’s already quite a lot of home bias from UK investors, but the actual performance of UK stocks, on the one hand that could be seen as very cheap at the moment. On the other hand, they might stay cheap for a while longer yet.

Jason Hollands
True, you know, global equities are dominated by the US and over a number of years US equities have significantly outperformed UK equities. But look, you know, investing is all about the future outlook and there’s no doubt that large internationally focused FTSE 100 companies are currently very, very cheap, astounding at the widest discount to global equities in decades, and they’re also very cheap compared to their longer-term average valuations and dividends are high. Now why is that? It’s partly down to gloom about the UK economy and investors often confuse the UK stock market with the domestic economy, which really isn’t the case because, as you highlighted, these are about generally very, very global businesses. But it’s also partly down to the make-up of the FTSE 100. It has negligible exposure to areas like technology, which of course has been one of the best areas of the market to invest in in recent years and where valuations are rich. But also the UK, particularly FTSE 100, has quite high exposure to parts of the market that ESG-minded investors steer clear of, like fossil fuel companies, commodities, tobacco.

Claer Barrett
BP, Shell. Yup. BAE . . . 

Jason Hollands
Yeah, absolutely. But there’s an opportunity here. It’s always a good starting point to buy shares when they do look cheap compared to where they’ve traded over the longer term. Of course things can stay cheap for a while or for good reasons. But I do think actually UK equities do look quite appealing at the moment. But of course that doesn’t mean that people should be strong armed to invest in them every year. And of course there are other ways that the government could encourage investment in UK companies. A really major one would be to restore the tax credits that pension funds used to receive on UK dividends, since those were scrapped by Gordon Brown. The amount of money that UK pension funds have invested in the UK market has plummeted. Of course, why not scrap stamp duty on UK share purchases?

Claer Barrett
That’s the one tax that you do have to pay even within an Isa.

Jason Hollands
Exactly.

Claer Barrett
It’s not very much. It’s only 0.5 per cent of the value of the UK shares or investment trusts that you would be purchasing. But nevertheless it’s a tax that you wouldn’t have to pay if you were buying, say, an ETF, a fund or shares in one of the big US tech stocks.

Jason Hollands
Correct. You know that isn’t a tax that you’re paying when you’re buying shares in an Isa in US companies. And although it is in some ways a token amount of money and probably wouldn’t drive someone’s decision as to whether to invest in a UK company or not, it would certainly be the right signal.

Claer Barrett
Well, Brian, to bring you in here, Moneybox customers who invest on your app tend to be younger. Do you think the idea of investing in UK equities would appeal to them?

Brian Byrnes
So it absolutely does. But I think as Jason mentioned, they already have their £20,000 Isa allowance to do that and I don’t think anybody’s looking at that 20,000 thinking it’s really in any way stingy. It’s quite a generous annual allowance. So we really think that this suggestion loses track of what Isa simplification is supposed to be all about in our eyes, and that’s supposed to be making things simpler for consumers to be able to make really good financial decisions and hopefully instil kind of good saving and investing behaviours in them for life.

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Claer Barrett
Now, one area where I think we’re both aligned in thinking efforts and resources should be focused on is this issue of fractional shares. Now I’ve quoted you in a piece for the FT before explaining what these are. If you want to buy a share in, say, Amazon or Apple, for example, using an investment app, as many young people do, because these are the brands that they see around them in everyday life, the prices of these US shares are quite high. I mean, I think the last time I looked, I think shares in Amazon and Apple were both well over $100. So the technology exists now to be able to buy smaller bites, little pieces, nice fractions of the shares, but that’s something that technically the Isa rules don’t allow. So tell us more about that.

Brian Byrnes
Well, I think, first of all, I would like to be very clear and say that we firmly believe that investing in fractional shares via an Isa is allowed at the moment and there’s a legal opinion to back that up. The problem is that the Isa regulations were written before fractional shares were a thing and therefore it’s not explicitly called out within the regulation . . . 

Claer Barrett
In the 1990s.

Brian Byrnes
Exactly. So the regulators are reading the same regulation that we’re reading and coming to a different conclusion, which in our opinion, is not in the best interest of consumers and investors. So some investors do like investing in individual shares. As you say, things like Tesla, things like Apple, they’re very, very popular. But as you say, their share price is well over £100 or £200 when you convert them over into sterling. So you would have to be able to invest quite a lot of money in order to be able to build a diversified portfolio of those companies that you’re interested in. And the strange thing is fractional shares are allowed and you can build that diversified portfolio outside of an Isa. But for some reason at the moment, there is just this discrepancy between whether it’s actually allowed within the Isa or not. And we think, as I say, we firmly believe that it is, but we’re just calling on HMRC and Treasury to clarify that in the Autumn Statement and just get rid of any uncertainty for investors because this is a really good way to get people engaged with investing early in life, investing in companies that they’re interested in at amounts far smaller than if they had to buy a full whole share.

Claer Barrett
Mmm. Fantastically explained there, Brian. It’s a story I’d love to write if they do clarify the rules on that. Now, finally, let’s talk about the simplification of the Isa product range and the future of the lifetime Isa because this is one thing that people have been talking about. Now, Brian, I’ll stick with you. The lifetime Isa — Lisa, as it’s called by some people — it’s come in for a lot of criticism. Does it deserve its place in the Isa range?

Brian Byrnes
I think it absolutely deserves its place. And again, our view is that it should be absolutely the cornerstone of this proposed reform. So I think the small amounts of criticism it does typically come in for is quite often from providers who don’t offer the lifetime Isa. And all you need to do is spend a little bit of time with people who save and invest into the lifetime Isa and you will hear that they absolutely love it and obviously they’re going to love something that gives them a 25 per cent . . . 

Claer Barrett
Well, yes. Explain to listeners who might not know how it works.

Brian Byrnes
Exactly. So the lifetime Isa, basically you can use £4,000 a year from your Isa allowance. You can put that into the lifetime Isa and the government will top that up by 25 per cent. So that’s an extra thousand pounds a year on top of your savings, which is amazing. You can use that for two purposes. One is to buy your first home up to the value of £450,000. Or the second one is to supplement your retirement income. You can withdraw from the lifetime Isa tax-free from the age of 60. If you don’t use the lifetime Isa for either of those purposes, there is a 25 per cent penalty on your money if you go to withdrawal. So that’s the basics of how it works.

Claer Barrett
OK. And then the criticism of the lifetime Isa is there’s a lot of rules, it’s a lot of potential things that could trip up young people. The 450,000 property cap, I have to say, is probably the thing that listeners complain to me the most about. But nevertheless, give us a flavour of how many young customers are using the lifetime Isa on your app and their enthusiasm for this product.

Brian Byrnes
Well, this is the thing. We have hundreds of thousands of customers using the lifetime Isa and as I say, if you spend any time with them whatsoever, they absolutely love it. We have thousands of verbatim comments saying this is absolutely incredible. It’s helped me hit my financial goals that I never thought was a possibility. And as I say, you’re obviously going to like something that gives you free money.

But on top of that, we have loads and loads of comments saying this has turned me into a saver, an investor, which I never thought I could be. It is getting people in their twenties, in their thirties, into the habit of saving investing. They are typically hitting a financial goal, an amazing financial goal of purchasing their first home within three, four or five years of the lifetime Isa. And they are taking those saving and investing habits into the rest of their life. So when I say that this is what, that should be the cornerstone of the Isa reform, that’s what I mean in terms of instilling these saving and investing behaviours. And again, like the rest of the Isa universe, there’s areas that can be improved and future-proofed. As I say, we are calling for that £450,000 cap to be to be regularly reviewed in line with house prices increasing. And we are also calling for some sort of emergency withdrawal allowance within the lifetime Isa. But these are small tweaks here or there that will just help people build more confidence in these products going forward.

Claer Barrett
And final point on the lifetime Isa. There’s two versions. You can save up in cash, so you get that cash deposit. Might also get a little bit of interest depending on who you provider is. But you could also use it to invest in stocks and shares. Now, Sarah, at the moment you have to be over 18, but under 40 to open a lifetime Isa. But Hargreaves Lansdown believes that actually this is something that the government could consider extending.

Sarah Coles
Yes. So one of the big issues that the whole industry has been trying to tackle is that self-employed people just aren’t saving enough for retirement and they’re afraid of putting their money into pensions because they tend to have lumpy incomes and they’re worried that they’ll lock it up and won’t be able to get access to it. So we think that the lifetime Isa can be a really good part of the solution. But in order to make it so, there are a couple of tweaks. And as you say, one of them is that it needs to be sort of accessible to people who are a bit older. So we’d like to see that the age that anyone can open and pay into it go up to 55. And this is because actually self-employed people tend to be older than employed people. So it’s something people go into later in life. And an awful lot of them are already over the age of 40 by the time the Lisa came along. So by changing the rules, it would sort of encompass all of these extra people as well.

Claer Barrett
Now, finally, we do not know for sure if the chancellor will make an announcement about Isas at the Autumn Statement on the 22nd of November. Obviously, we’ll be debating it on our special Money Clinic episode if he does. But panel, if you had your hands on the red briefcase of power, what’s the one thing that you would do to make Isas more attractive? Starting with you, Jason.

Jason Hollands
It’s a very simple thing. I would actually increase the allowance. It’s been frozen now for six years. Were it to have been adjusted for inflation, it would today, in real terms, would be almost £26,000. So that is a very simple change that could be made to restore the real value of the Isa.

Claer Barrett
Excellent. It would generate lots of headlines and boost the knowledge about Isas more, I’m sure. Sarah, what would you like to see?

Sarah Coles
Well, it doesn’t sound like it’s an Isa change, but what we’d really like to see is some concrete change on what’s known as the advice guidance boundary. So it sounds particularly confusing, but it’s really it’s around how much information a financial company that you use can give you before they cross over from guidance, which they can give to anyone into financial advice, which is a whole other separate process. So we’d like companies to have the freedom to be more helpful, and that in turn they’d be able to explain products better, they’d be able to direct people to the things that suit them, and then that would then encourage people to save and invest more so it wouldn’t just help them make more informed decisions about Isas themselves, but by everything. So pensions, Isas, the lot. So we think that will be a really, really big and important change. There’s already been lots of discussions, but we just like to see something concrete come together now.

Claer Barrett
And last but not least, Brian, what’s the one thing that you would like to see?

Brian Byrnes
So I would future-proof the lifetime Isa by raising the £450,000 house price cap with house price inflation on an annual basis, and we would also introduce some sort of emergency access without losing any of your own money and being penalised with your own money. So this would turn the Isa, younger Isa users, into savers and investors for life.

Claer Barrett
Gets my vote. Well, I’ll throw in one of my own for good measure, although I have to say lots of FT readers mentioned this on our original Isa story. Why call them Isas? Why not call them tax-free accounts? That’s what it says on the tin. Saves you lots of tax. Times like these, maybe that will attract more people to try and find out more about how Isas could work for them. Well, all that remains for me to do is to thank our fantastic panel of experts: Brian, Sarah and Jason.

Brian Byrnes
Thank you for having me.

Sarah Coles
Thanks a lot.

Jason Hollands
Thank you.

Claer Barrett
And I hope that everybody listening has now got a much better handle on how cash Isas, Lifetime Isas and indeed stocks and shares Isas could help you hit your savings and investing goals in future.

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That’s it for Money Clinic with me, Claer Barrett, this week. And we hope you like what you’ve heard. If you did, spread the word and leave us a review. We’re always looking to chat with people about their money issues for the show. So if you’re interested in being part of the future episode, then email us. Our address is money@ft.com. You could also take a peek at our website, ft.com/money, grab a copy of the FT Weekend newspaper or follow me on Instagram. I’m @ClaerB.

Money Clinic was produced in London by Philippa Goodrich. Sound design is by Breen Turner, and our editor is Manuela Saragosa. You heard original tunes this week by Metaphor Music. Cheryl Brumley is the FT’s global head of audio. And finally, to repeat our disclaimer: the Money Clinic podcast is a general discussion around financial topics and does not constitute an investment recommendation or individual financial advice. For that you’ll need to find an independent financial adviser. That’s all the small print for now. See you back here next week. Goodbye.