A new tax year is upon us – and that means, for all the diligent savers and investors out there, a new Isa tax-free saving allowance.
This year the main allowance has been substantially increased, a new product has been added that offers government top-ups and Budget 2017 has just made saving outside an Isa significantly less attractive.
All of which means saving via an Isa – and examining your investment options for tax-sheltered funds – is more important than ever.
What are the allowances for 2017/2018?
The main allowance has risen from £15,240 last year to £20,000 this year. That’s the maximum amount every person can save into any type of Isa over the course of the tax year.
What are the Isa options?
Most obviously, there are Cash Isas and Stocks and Shares Isas. The former holds cash like any other savings account (only tax free), while the latter is a tax-free “wrapper” that can be used to house a range of investments.
For under 18s there are Junior Isas, which can be either cash or stocks and shares and have a lower annual allowance of £4,128 this year.
Then there is the Help to Buy Isa, which is a cash Isa that offers a 25 per cent top up on regular savings of £200 a month for any funds used to pay the deposit on a first home.
This year a new addition has come in the form of the Lifetime Isa, which is basically a Help to Buy Isa that also rolls money up to support pension savings. It has an annual allowance of £4,000 and offers a 25 per cent annual bonus up to the age of 50.
Finally there is the Innovative Finance Isa, which is a specialist tax wrapper for higher-return peer-to-peer lending investments.
Any small print?
There’s a few things you need to be aware of, which your broker can fill you in on. Examples include that you can only open one Cash Isa a year – and that includes Help to Buy Isas.
For Stocks and Shares Isas there are limits on the type of investments that can be housed, including all standard investment funds and trusts, exchange-traded funds, and government and corporate bonds.
What happened in the Budget?
Philip Hammond insisted he would balance any new spending with new taxes. So to pay for a boost to social care funding – and in addition to the abortive national insurance hike for the self-employed – he upped taxes on dividends by a cumulative £2.6bn.
He did this by cutting the allowance for dividend earnings from £5,000 a year to £2,000. It means you can earn 60 per cent less a year in income from your investments before you need to pay tax.
So Isas are more useful?
Overall, yes – and if you want to make and accumulate income-based investments, especially so. That £20,000 allowance this year looks very generous now.
Should I invest for income?
Many people like the regularity of income-paying assets, but also the potential for big gains from capital growth (simply a share price increasing over time and so adding to your asset value). Most portfolios will include a blend of income and growth-based returns.
What about low interest rates?
It’s certainly true that low interest rates have eroded the value of a lot of income-based based assets – and the low-rates environment doesn’t look like ending any time soon.
There are some options to boost income. One such, which has been available since a law change in 2012, is enhanced dividends.
Since that time investment trusts have been allowed to enhance or increase dividends or the income they pay to their shareholders by realising gains on some of these pooled funds’ underlying portfolios of assets.
This can make these trusts more attractive to investors whose priority is income – for example, people who must live off their savings to some degree, such as pensioners using income drawdown.
Which trusts offer enhanced dividends?
It’s completely at the discretion of any investment trust to offer enhanced dividends and it depends on the state of the balance sheet and underlying asset pool.
There have been some corollary benefits, too. Independent research by the stockbroker Winterflood Securities found that after these trusts introduced enhanced dividend policies last year, their discounts narrowed significantly.
The discount is the amount by which the sale price of shares is worth less than the net asset value – so the amount an investor would forfeit from the value of their holdings if they sold them on.
Are there any downsides?
Potentially. One risk of an investment trust selling some of its underlying assets to generate gains in order to enhance dividend payments to its shareholders is that it might end up ‘eating next year’s seed corn’.
Put simply, shares that are sold to boost dividends today cannot generate any returns to the existing holder in future.
This is why investment trusts’ independent boards of directors regularly review whether enhanced dividend policies remain in the best interests of all shareholders. And it’s also why you should seek to ensure a good mix across your portfolio.
In general you should make sure your portfolio overall matches your risk appetite and tolerance – which defines how much you could afford to lose if things went bad.
You can do this by going through online brokers, which offer questionnaires to assess your risk level and then have off-the-shelf portfolios to suit, or by going through a fully fledged financial adviser.