The continuation of record low savings rates and the latest decision by the governor of the Bank of England to provide forward guidance on interest rates combine to leave millions of savers with little hope of change in the coming years. However, those with Cash ISAs do have one further option to consider – the ISA transfer. We take a closer look at why this is becoming a rising trend as well as what this could mean for those looking for the potential to improve the returns from their capital.
Historically low interest rates
The current Bank of England rate continues at its historical low of 0.5%, a level it has been since March 2009 – that’s 53 months in succession. No one has felt the impact of this more than the fixed rate saver with yields available also seeing record lows, especially on the longer terms. Peace of mind along with a competitive deal have vanished completely.
The result is that millions of savers with money held on an instant access basis or who have fixed rate bonds maturing are facing significant drops in the level of interest available from similar products, many falling by as much as 50%.
Interest rate rise any time soon?
In short, no. In his first major speech since becoming Governor of the Bank of England, Mark Carney told business leaders assembled in Nottingham that interest rates would not rise from 0.5% unless unemployment falls to 7%. He added that there was only a one in three chance of this happening within the next two years.
According to official figures the UK’s unemployment rate is presently 7.8%. However, based on its latest Inflation Report, the Bank of England expects median unemployment to stand at 7.3% per cent over the next three years, meaning the base rate is likely to remain at its historic low throughout the forecast period with no shift on the horizon until 2016 at the earliest.
Record low savings rates
While this is great news for businesses and individuals who are borrowing, it brings no joy to savers who still have money held in cash accounts. With instant access account currently offer around 1.6%, notice accounts up to 1.9%, 2 year fixed rates around 2.2% and longer term fixed rates only offering around 3% at the top end, it is immediately clear that things are bad.
Indeed, with inflation at 2.8% research by Which? Money in August revealed that just one account, out of 804 cash accounts, had a rate that would beat inflation for a basic rate tax payer and for this you had to tie your money up for 7 years and had a maximum contribution limit of £10,000. This means that nearly all cash savers are currently losing money in real terms.
Also remember that if you do tie yourself in now and inflation goes up by only a small amount during your fixed term, your real return (i.e. the return after inflation and tax) could erode even more quickly – you must therefore take a view of what could happen before acting.
The importance of Cash ISAs
With this current environment of record low savings rates, the impact of tax on our net returns is even more evident. Since the headline rate advertised is often the gross return, all but non-taxpayers have to deduct a minimum of 20% to find out how much they will receive in their pocket.
This highlights the importance of using our ISA allowance in order to provide returns tax-free, regardless of our marginal rate of tax. The cumulative effect over time therefore allows us to protect a significant sum against the effects of taxation. The compound effect of receiving tax free returns becomes even more prominent over time so even if you are unable to put the maximum in, making some use of your annual allowance should be a top priority.
ISA basics – how much and how often?
The ISA allowance for the current tax year (6th April 2013 to 5th April 2014) is £11,520. Subject to this overall limit, you can put up to £5,760 in a Cash ISA and the remainder of the £11,520 into a Stocks and Shares ISA (Investment ISA) with either the same or another provider. So, for example, you could put:
• £5,760 into a Cash ISA and £5,760 into an Investment ISA
• £3,000 into a Cash ISA and £8,520 into an Investment ISA
• nothing to a Cash ISA and £11,520 to an Investment ISA
The ISA allowance is per person with a minimum age of 16 for Cash ISAs and 18 for Investment ISAs. If you do not use your ISA allowance during any tax year it is lost, i.e. unused ISA allowances cannot be rolled over into future tax years, hence the phrase ‘use it or lose it’. Please note that tax treatment depends on legislation and your individual circumstances which may change in the future.
Cash ISA transfers
If you have already used your Cash ISA allowance this year you can still transfer it, although in the situation you must transfer all of it. If you have taken out a Cash ISA then you can still top up another £5,760 when transferring it into an Investment ISA. If you have not taken out either a Cash ISA or an Investment ISA this year, then up to £11,520 can be invested into the latter.
Subscriptions to an Investment ISA can only be transferred to another Investment ISA, however, subscriptions to a Cash ISA can be transferred to another Cash ISA or to an Investment ISA. One important point to note is that when a Cash ISA is transferred to an Investment ISA, it cannot then be transferred back to a Cash ISA. You should also remember to check whether there is any penalty to transfer before proceeding.
Finally, if you transfer a current year Cash ISA payment to an Investment ISA, it is as if that Cash ISA had never existed. Any money you saved up to the date of transfer will be treated as if you had invested that money directly in an Investment ISA. This means you can still make further payments to a Cash ISA in this tax year provided you haven't already used up your annual ISA investment allowance, currently £11,520.
For example, if you had put £2,000 in a Cash ISA and then transferred it to an Investment ISA you would be able to make further payments totalling £9,520 in that tax year. You could either put all of the £9,520 in an Investment ISA or you could put up to £5,760 in a Cash ISA (with the same or a different ISA manager) and the remainder of the £9,520 in the Investment ISA.
A rising trend
With interest rates likely to remain low for quite some time, there has been an increasing trend of savers transferring their Cash ISAs to Investment ISAs as savers are being challenged by the savings rates on offer to give up the security of cash for potentially better returns.
Transferring your Cash ISA is easy and as highlighted above can be done without the loss of your ISA wrapper and it will not affect your annual ISA allowance for the current tax year. However, if you are considering this option you should be aware that Cash ISAs and Investment ISAs are very different and that Investment ISAs put your capital at risk. Once you have transferred to an Investment ISA you cannot transfer back to a Cash ISA.
Cash ISA transfer option
Unfortunately, for those with Cash ISAs the market currently offers nothing that beats the headline rate of inflation, regardless of whether you are willing to tie your money up in the longer term.
For those willing to take on risk to their capital in the hunt for higher returns, one of our most popular Investment ISAs for savers who previously relied on fixed rate bonds for income is the Enhanced Income Plan from Investec which provides 5.76% fixed each year (0.48% each month), paid to you regardless of the performance of the stock market.
The plan has a six year term and also contains conditional capital protection which means that your initial investment will be returned in full unless the FTSE 100 Index falls by more than 50% during the investment term. If it does, and the Index also finishes below its starting level then your original capital will be reduced by 1% for each 1% fall. Therefore, this plan should only be considered if you are prepared to lose some or all of your capital.
Since the income is fixed, it can more easily be compared with a fixed rate bond. Leading longer term fixed rates are offering around 3% so the level of fixed income on offer from the Investec plan provides a significant increase and if taken out through a new ISA or by transferring existing Cash or Investment ISAs, this income is tax free (the plan is available for non-ISA investments).
The trade off is that if the FTSE falls by more than 50% of its starting value during the investment term, your capital is at risk. This investment risk is clearly defined at the outset and permits both savers and investors to consider whether they are prepared to put their capital at risk in return for the high fixed income on offer.
Fair Investment conclusion
Commenting on the investment, head of savings and investments at Fair Investment Company, Oliver Roylance-Smith, said: “The high level of fixed income and the monthly payment frequency are attractive features of the Investec Enhanced Income Plan and with savings rates continuing at historically low levels there is sizeable pressure mounting on savers to seriously consider what is the best home for their money.”
He continued: “Unlike savings plans, investing puts your capital at risk and so you should only consider this investment is you are prepared to lose some or all of your initial capital. However, should you consider the need to move some of your capital into investments or are considering additional investments or ISA transfers, this plan could be a compelling opportunity to provide a competitive level of fixed income while offering your initial capital some protection against a falling market”.
Click here for more information about the Investec Enhanced Income Plan »
No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular plan. If you are at all unsure of the suitability of a particular product, both in respect of its objectives and its risk profile, you should seek professional advice.
The Investec Enhanced Income Plan is a structured investment plan that is not capital protected and there may be the risk of losing some or all of your initial investment. There is also a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated, in which case you may not be entitled to compensation from the Financial Services Compensation Scheme (FSCS). In addition, you may not get back the full amount invested if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.
© Fair Investment Company Limited