How to get the best out of the ISA tax break

The 'staged approach' to help the over-50s could make it hard to understand.

(PETER MACDIARMID / GETTY IMAGES)

The decision to raise the amount of money that Britons can pay into an individual savings account (ISA) each tax year from £7,200 to £10,200 has been welcomed by most consumer groups, financial advisers and banks. In these times of microscopic interest rates, it ought to be a win-win scenario for savers to be allowed to invest more money free of tax.

But even when it is giving a tax break, the Treasury never makes things simple. "The approach they have taken is so convoluted and confusing that many people are not going to know where they stand. Also, what does it do to encourage those who aren't saving at present?" says Darius McDermott, managing director of the investment advice firm Chelsea Financial Services.

The main bugbear, however, seems to be the decision to implement the raising of the ISA savings in stages. From 6 October, those aged over 50 will enjoy the new ISA limit, but those under this age will have to wait till the following tax year before they can start to benefit. The basic structure of ISAs is being kept the same, with half the allowance available to be paid into a cash account and the other half into a stocks and shares vehicle. Alternatively, savers can choose to put the whole £10,200 into stocks and shares.

"All this complexity over ages and amounts is going to cost a fortune for businesses to put systems in place to handle," adds Mr McDermott. "It's OK for the big banks, but fund managers may have to spend millions in this tight environment to allow them to take investments from the over-50s above the current ISA limit. It's all very ham-fisted."

Gareth Thomas, the minister for Consumer Affairs, explains why the staged approach was necessary: "We needed to address an immediate problem. Interest rates have come down substantially, and there are over five million pensioners with savings of less than £10,000 who rely on the interest. We have to wait for October for banks and building societies to put their systems in place, but we wanted help this tax year."

Those who are over 50 and therefore qualify for the new enhanced ISA limit in October should act now, say market watchers. "If people sit back and wait for October to open a cash ISA, they will be missing out on the tax break. The thing to do is to open an account now, pay in the maximum £3,600, and then top it up come October with a further £1,500," says Michelle Slade from the financial information service Moneyfacts.

However, providers are expected to rush out some more attractive priced savings account in October: "I expect that we will see some new account launches hoping to capitalise on the publicity surrounding the higher ISA allowance near October. But what people can do is take advantage of a best buy now, and if they see something better come October, then do an ISA transfer," Ms Slade says.

Current ISA best buys include 3.56 per cent from Manchester Building Society with a 45-day notice, or 3.55 per cent from the Barclays' Golden ISA account.

The reason the Government gave for increasing the ISA limit is that it wants to allow savers to keep more of their interest. However, the decision does mean that stock-market investors can benefit too, as funds or stocks and shares held in an ISA are allowed to grow free of capital gains tax.

"This is a good time to look at investing in shares and bonds. Stock markets have nearly halved since the credit crunch started, so you have to believe that there is a good chance that values will grow from here. As for bonds, companies are paying high interest to attract people to buy their bond issues as a result of the tighter bank lending," Mr McDermott says.

But should the over-50s really be looking at stock-market investment, considering that it can be a high-risk business?

"Of course, it depends on the age and attitude to risk of the individual. But someone in their 50s still has quite a while to wait before retirement, so they can afford to at least take some risk. What's more, the returns on deposit accounts, regardless of the ISA tax break, are so poor at present that you might as well try another approach," adds Mr McDermott.