NISAs lead savers into a brave new world

The government confirmed itself as a fan of the ISA concept in the 2014 Budget, by increasing the amount of money that can be diverted into individual savings account wrappers and opening up the ways the money can be invested.

Many have labelled it a revolution for ISAs - but for those investors who have been dutifully squirreling away their savings for years, the new powers may not appear immediately groundbreaking. Nevertheless, the new ISA freedoms do amount to a notable expansion to an investor's tool kit.

The changes are both in the structure of ISAs and in the investment options. The structural changes are small, but important. From 1 July 2014 all ISAs become New ISAs (or "NISAs", in a nod to the headline writers).

Cherry Reynard adds that the new ISA regime also opens the door to inheritance tax planning, P2P lending and retail bonds, in: NISAs will improve investors' financial planning options.

Greater flexibility

Not only is the NISA more generous, with investors able to shelter up to £15,000, but it also does away with the historic distinction between cash and stocks and shares, granting investors full flexibility to switch between the two. Under the new rules, investors can also transfer previous years' ISA savings freely between cash, and stocks and shares.

This means that investors can now invest everything in cash, rather than using just half the allowance. This isn't immediately appealing - the top rate of interest on an instant access cash ISA remains at just 2% (from Coventry BS, according to Moneyfacts) - but the flexibility is important.

It means that investors can put cash in an ISA and then invest it gradually in the stock market as opportunities arise, or take money out of the market without complex ISA transfers or the loss of their allowances if times get tough. The current market climate, in which the stock markets may be drawing to the end of a lengthy bull run, could be one occasion when this flexibility is useful.

Mark Stone, client services director at Whitechurch Securities, says that this new cash to stocks and shares flexibility is likely to have most use for those investors who have been dragged into higher-risk assets by lower interest rates, but will want to revert to cash when interest rates rise: "If interest rates get to a level where they can generate the income they need while having little risk to capital, we may find people go back the other way."

However, investors do need to be aware that not all providers will offer this flexibility instantly.

For example, Justin Urquhart-Stewart, marketing director of Seven Investment Management, says: "Historically, cash ISAs have been run by banks and building societies and stocks and shares ISAs have been run by investment groups and neither had to think particularly hard about the other.

"Now these need to be patched together. The stocks and shares providers have had to handle cash anyway so it should be straightforward for them, but many of the cash ISA providers may not be geared up to handle investments. I would caution any investor to check what a provider can offer in advance."

Retirement options

The extension of the allowances makes ISAs more valuable as a financial planning tool and brings them near to pensions in importance. An investor who put £1,250 into an ISA every month (amounting to £15,000 a year) for 20 years, compounding at 5% (including charges), could expect to generate a pot of around £514,000. Invested in a standard equity income fund paying 4.5%, this could generate a tax-free income of £23,130. That's a valuable option for everything from school fees to retirement.

As Petronella West, investment director at Investment Quorum, observes: "ISAs have always been a valuable tool for financial planning, but having a limit of £15,000 gives a lot more scope to use them as a retirement savings vehicle. Although investors will pay in from taxed income, they can generate a tax-free income stream to give a healthy return alongside pension income."

Stone adds that a married couple can now get £30,000 into an ISA. This is less than for a pension, but it is equalised across both spouses, rather than lower (because the rate of tax relief is less) for one lower- or non-earning spouse, as is the case with pensions.

Stone says he recommends for most clients that their basic lifestyle needs are met by their pension income, with the income from an ISA paying for the "nice-to-haves" such as holidays.

He adds that using ISAs can also help investors manage the traditional "U-shaped" needs in retirement: people usually have greater income requirements at the beginning of their retirement, when they are more active, and at the end, when they may have care home costs. ISA income can be taken initially, then rolled up for a number of years, and then used again at the end.

Urquhart-Stewart says that earlier in life it is the flexibility of the ISA that is most important: "A pension is still a locked box. An investor can't do anything until drawdown. They have more flexibility after the Budget changes, but they are still limited. With ISAs, investors can take an income, or roll it up, or take cash out, or even borrow against it." Moreover, they can do any of these things at any time, while pension planning options only start at 55.

School fees planing

One key beneficiary of the increase in ISA limits is the parent or grandparent saving for school fees, says Matt Pitcher, senior client partner at Towry. "The 2014 annual census from the Independent Schools Council suggests that the average termly fees are £4,998 and that fees have risen 3.9% in the last year. This shows how large an accrued fund is needed to pay for school fees, and also how quickly the fund has to grow to stay ahead of fee increases.

"The NISA limits now mean that a couple can between them save the annual cost of two children's private education in a tax-efficient environment.

"Clearly the earlier they start the better, but for these individuals every little helps."