Why contractors won’t agree that ISAs don’t work

The 2010/11 tax year was a year of change, with everything from child tax credits to pension tax relief coming under fire. As we move further into a new tax year, it looks like Individual Savings Accounts may be the next target for change, given that they’ve already become the target of criticism, writes Tony Harris, founder of Contractor Money, an independent financial advisor to contractors.

‘ISAs don’t work’

There have been a number of headlines in recent weeks, such as “ISAs don’t work”, which have triggered calls for the current ISA system to be shaken up to encourage savings among families. This debate came after a report by the Institute for Public Policy Research found that more than half of UK households have inadequate savings. In terms of ISAs, such tax-free accounts have failed to boost the saving ratio, IPPR claimed, adding that most of the tax relief they offer goes to people who would have saved anyway.

How much can contractors save in an ISA?

The current ISA set-up enables contractors to invest up to £10,680 a year - and benefit from tax free growth on their savings – which I don’t hear many contractors sniffing at. The critics suggest that this amount, and the zero tax liability, is not enough of an incentive to encourage savers to invest. There have been a number of ideas thrown into the hat as a result, such as offering a bonus scheme that is linked to the amount that you save each year, or the opportunity to reduce your National Insurance liability to bring ISA’s in line with the tax relief available on pension contributions.

It remains to be seen which route, if any, the government will decide to take. But for now, ISAs will continue to offer tax-efficient savings to contractors, as you can benefit fully from any growth on the investment rather than facing the tax charges associated with traditional savings accounts.

ISA ‘and’ pension, not ‘or’ 

The recent increase in the annual ISA allowance to £10,680 allows contractors to save a significant sum and, over time, this could help to provide an income in retirement to accompany your pension. The only potential downfall of an ISA as an investment vehicle is that you can easily access your funds at any time. While this may sound like a positive feature, it can be tempting to dip in to your savings, knowing you can do, which could be ill-advised if you plan to use your ISA as a nest egg.

In our experience, ISAs tend to work well alongside a pension to ensure you have a long-term savings plan, offering easy access to cash if required in the short-term. We tend to recommend that clients have at least three months expenditure saved for a rainy day - cue your ISA allowance, which offers the perfect opportunity for contractors to shield these funds from the taxman.