NISAs will improve investors' financial planning options

As well as the raised allowance and retirement options, ISAs can now also offer some tax planning options around inheritance tax (IHT), primarily via the extension of the investing rules to Alternative Investment Market (AIM) stocks. In normal circumstances, ISAs (including cash ISAs) will be subject to 40% IHT when the saver dies.

Mark Williams, business line manager for IHT at Octopus Investments, says: "The exception to that has been available since August last year, when the government changed the ISA rules to for the first time allow direct holdings of AIM shares in ISAs.

"Shares in certain AIM companies will qualify for full relief from IHT once they've been held for two years, if they're held when the saver dies."

Octopus launched an AIM Inheritance Tax ISA in September last year and a number of other groups, including Stellar and Killik & Co, offer a similar managed portfolio of AIM shares.

IHT planning

Williams says: "We're expecting that there will be a good proportion of elderly investors who choose to use the increased ISA allowance to invest in AIM, both to benefit from the growth potential of smaller companies, and so they can pass on as much of their savings as possible to their loved ones when they die."

Of course, this comes with certain caveats. The AIM market largely focuses on smaller, higher-growth companies that do not want the administrative burden of a full stock market listing. This includes some well-recognised companies such as ASOS or Majestic Wine, but they are generally niche businesses. The risks are therefore higher. "Investors need to proceed with some caution," says Petronella West, investment director at Investment Quorum.

"AIM stocks, for example, are highly illiquid. For wealthier investors they can shelter a lot of capital gains, but they are not for everyone. AIM is a good option for those looking for high capital growth. It may be right for someone young, who can take a lot of risk. Equally, there are a number of good managed options."

However, she cautions that in markets such as those seen in 2008, liquidity can dry up completely and costs can be high on some managed AIM portfolios.

There are other changes to the ISA structure that may also allow more financial planning options. For example, the introduction of peer-to-peer (P2P) lending as an investment option in the last Budget could provide either a new income or growth option, depending on how the scheme is structured.

There are a number of P2P lending sites emerging: some offer equity in a company in exchange for investment, while others use more conventional loan arrangements.

P2P lending appeal

P2P lending has the appeal of supporting smaller companies that have suffered as the banks have withdrawn from riskier lending. Karteek Patel, director of alternative funding advisers at Nineyards Capital, says some estimates suggest that lending to small to medium enterprises has fallen by up to 30% and this area could really benefit from the extension of ISA freedoms.

Invest and Fund is part of the new breed of P2P lending groups that may become allowable under the new ISA rules. The site allows investors to build a portfolio of investment opportunities in small businesses, with a starting level of £25. The attraction is that it is possible to direct money to local businesses that have been denied funding as mainstream banks have moved away from lending to this type of enterprise.

Chief executive David Turner says: "We see it as an industrial revolution for the banking industry, bringing lending into the 21st century. Perhaps most importantly, it is about supporting the local economy and local businesses."

The technology allows investors to select the parameters of their return. Investors can decide whether they want to take higher risk, or only invest in certain industries. They can even decide to invest only in certain postcodes. Certainly the idea of "disintermediating" banks - and doing away with the costs they impose - can be appealing, as is the idea of a more "personalised" investment.

However, while P2P will bring a new source of diversification and, potentially, income to an ISA portfolio, many advisers think private investors may not be aware of the risks involved, including the potential for capital loss.

Patrick Connolly, chartered financial planner at Chase de Vere, adds: "Investors need to be aware that P2P carries additional default risks, and investments are also not protected by the Financial Services Compensation Scheme," he says.

West says she is monitoring a number of schemes and believes there will be opportunities in the market, but has not yet recommended it to clients: "P2P lending can produce significant capital gains, but just because investors can do it, doesn't mean they always should."

Retail bonds

The other area of interest for investors is in retail bonds. In the Autumn Statement last year, the government said it was considering allowing retail bonds with a maturity term of less than five years to be held in ISAs.

Patel says: "The government has changed the terms of the bonds in which people can invest. This additional freedom could open up quite a big market in the retail bond space. At the end of 2013, around 80% of the money going into ISAs went into cash ISAs.

"Most people use ISAs as [a way to provide] access to cash, but if the government reduces the term of the debt securities, we might see investors switching cash holdings for shorter-term debt paper. The fuzzy line between cash and stocks and shares disappears."

For many investors this type of investment may have more appeal than traditional stockmarket investment. Stockmarket investment can be faceless and the thought of supporting local businesses can be more engaging, argues Patel. "Investors have become more educated, more empowered and these type of products have an emotional catch for them," he says.

Connolly concludes: "While greater flexibility is welcomed, with more choice comes more scope for people to take bigger risks and to potentially make the wrong decisions. For most people the starting point for any investment strategy should be asset allocation, which will usually involve a combination of cash, equities, fixed interest and property."

The new freedoms expand an investor's toolkit and improve the financial planning options available to ordinary individuals, but many may not find the changes immediately transformative for their portfolios.