Question regarding investing in an ISA

[chris79]

This might seem a little obvious, but I just want to get opinions on the situation (well my perception of the situation) really:-

I'm still quite relatively young (you can probably guess my age from my name), and before I started contracting 2 years ago I had pension contributions in schemes elsewhere.

Since contracting I've been working on the basis that I ignore pension and use the extra money I have after living costs to pay off my rather large mortgage, as my logic here is paying debt off is just as good (if not better) than saving, and the sooner I get it paid off the better, at that point I can start investing the money I was paying on interest and capital repayments into something smart to build up a retirement pot.

Ok, so far so good! .... I got a letter through my door today reminding me to invest £3000 into my tax free ISA and it got me thinking.. if the chance to put £3000 away every year goes by, then each year I miss, is a year I'm missing investing money tax free. On this basis I should max out my cash ISA every year rather than paying £3000 extra off my mortgage for the simple reason I can't go back in time to use up that tax free allowance if I miss it. The return rate of the tax free interest is probably more than I pay in interest on my mortgage (I got a good long term low fixed rate a while ago) so at worst I would break even, at best I might actually make a few quid?

Does this seem a logical thing to do? Or am I in the wrong game completely in terms of where I'm investing for the future.

Thanks in advance!

[mcskiver]

I'd imagine that the interest saved on your mortgage is probably a lot higher than the additional interest you get from an ISA.

If it's a cash ISA, then all you're doing is putting 3 grand in a savings account and not paying tax on the interest, so you get around 6% instead of 5.2% (i'm vague on the figures but I was checking this out myself a couple of weeks ago).

So the interest on 3K over a year - around £180 - is tax free. If you put this 3K in a standard savings account, it would earn about £150 quid over the same period - not anything to get excited about. So if you're putting cash towards your mortgage instead and literally have no savings, then keep doing it. The only benefit in your case with a cash ISA that I can see is if you do have a couple of grand that you've saved.

The other point to bear in mind is that you can put 3K per year into an ISA, so after 5 years you could have £15K in there, and in that 5th year you obviously then get interest of around £800 (ish), a bit more substantial!

I'm no IFA by the way, but having looked into this myself recently, I came to your original conclusion - put the extra money against the biggest debt you're ever going to have...

[MrRobin]

Well, on the face of it yes the choice is obvious. If you have the spare cash after your monthly payments and you can get a better ISA tax free rate that you are paying on your mortgage then it makes sense to put the money in the ISA.

There is also the consideration on how much extra you can pay on your mortgage before your lender charges you early repayment charges. Most fixed rate mortgages have limits on how much you can overpay per month, typically up to the value of your monthly payment, each month, so unless you are playing £3k a month on your mortgage, you wouldn't be able to use the equivalent of your ISA allowance all at once, and you would miss out on a few months worth of interest - i.e. this strengthens the case of using the ISA

IANAA / IANAIFA

[Gonzo]

There isn't really a right or wrong answer on this, there are some that would argue that in a rising property market it is a good idea to take on additional mortgage debt to buy a bigger (or more) property.

But it depends on your priorities and your attitude to risk.

I wouldn't let the fact that you would receive some interest tax free steer you away from your original goals. There are other tax free savings accounts (with National Savings) but they do not have particularly attractive rates so would you consider them? Probably not.

In your position, if I was in the last couple of years of paying the mortgage off then I would consider diverting some money to an ISA and keep the mortgage running longer, but if there are still several years to go then I would concentrate on getting rid of that.

I am not a financial adviser and not authorised to charge for giving this advice Past performance is not necessarily a guide to future performance, the value of your investment and the income from it can go down as well as up.

[chris79]

Well if I play my cards right then I could probably clear my mortgage in 8-10 years...

But in 8-10 years time, thats 8-10 years of tax free investment missed... I could just pay my mortgage off say over 16-20 years, but at the end of it have a pot of 20 x £3000 (plus interest) giving me tax free interest every year out of it, if you see what I mean.

It's more a case of making use of the £3k maximum investment allowance every year which is my main concern here.

[MrRobin]

HOWEVER! You shouldn't shun your pension, especially if you have time on your side at the moment. Remember that you get an instant boost when you invest in a pension, and if you stuck in £3,000 it would instantly grow to £3,846 because of the tax reclaim. If you didn't draw your pension until you were 68, this £3k injection would make your pension worth almost £40,000 more (assuming 6% interest rate).

[chris79]

HOWEVER! You shouldn't shun your pension, especially if you have time on your side at the moment. Remember that you get an instant boost when you invest in a pension, and if you stuck in £3,000 it would instantly grow to £3,846 because of the tax reclaim. If you didn't draw your pension until you were 68, this £3k injection would make your pension worth almost £40,000 more (assuming 6% interest rate).

I'm not very informed about pensions, but I don't want to be tied into something until the age of 65 etc.. ideally I want to be able to semi-retire by the time I'm mid 40's, or at least have a pot of money big enough to give me the freedom to pick and choose what to do with my life (i.e. no requirement to work mon-fri etc)...

The other thing I was wondering is why isn't the £3000 ISA limit linked to inflation, it never rises year on year?

[MrRobin]

I'm not very informed about pensions, but I don't want to be tied into something until the age of 65 etc.. ideally I want to be able to semi-retire by the time I'm mid 40's, or at least have a pot of money big enough to give me the freedom to pick and choose what to do with my life (i.e. no requirement to work mon-fri etc)...

The other thing I was wondering is why isn't the £3000 ISA limit linked to inflation, it never rises year on year?

Well that's fine if you are very disciplined and won't be tempted to take it out before hand then it would be a nice little pot in 20 years time. But I doubt it would be enough on it's own to fund a retirement! Don't underestimate the tax remate on pension contributions though.. and you can start drawing from a private pension from age 50 (I think) so you don't HAVE to wait until the gov tells you are at retirement age.

The lack of increase of the ISA cash limit has been criticised for a while and the gov finally increased the limit to £3,600 - starting from April 08

[SueEllen]

I'm not very informed about pensions, but I don't want to be tied into something until the age of 65 etc.. ideally I want to be able to semi-retire by the time I'm mid 40's, or at least have a pot of money big enough to give me the freedom to pick and choose what to do with my life (i.e. no requirement to work mon-fri etc)...

The other thing I was wondering is why isn't the £3000 ISA limit linked to inflation, it never rises year on year?

The limits changed in this budget. http://www.guardian.co.uk/money/2007...et2007.budget5
(First link I've found with full explanation from google)

The government invented ISAs to replace other tax efficient savings schemes, and to boast savings in the country. The limits where never initially changed as the government planned to scrap them by around now.

Ideally you want to overpay your mortgage, have a pension and have other investments including ISAs that way you spread your investment risk.

Here's a calculator to work out if you should overpay your mortgage or save:
http://www.moneysavingexpert.com/mor...ges-vs-savings

Seriously as you have youth on your side you should investigate putting money into a pension especially if you have close relations who have lived into their 90s.

Also the earliest you can withdraw money from a pension is 55.

Pensions are just a tax wrapper for savings and if you invest from your personal income you get tax relief which is worth it if you are a higher rate tax payer as by the time you withdraw your pension you shouldn't be one.

More information can be found here:
http://www.moneymadeclear.fsa.gov.uk.../pensions.html (government site)
and on ISAs and SIPPS here http://www.moneysavingexpert.com/ban...PensionInvestm (private site but provides good financial advice)

[chris79]

Thanks for the replies here, they have been very informative and useful! I'm cautious to make the right decisions now, because of the snowball effect implications it can have by the time I get older!