All IFAs will understand the importance of clients using their annual Isa allowances as much as they are able to. This is a message that has been sinking in with savers and investors over the years to the extent that many now have significant Isa portfolios.
However, with many clients currently wary of stock markets, a challenge for advisers may be ensuring that client portfolios are not too heavily weighted toward cash and other lower risk investments to the extent that future investment growth prospects may be muted.
It is possible to earn interest of more than 2.5 per cent a year on variable rate cash Isas. This may seem attractive to clients with base rates still sitting at 0.5 per cent a year and seemingly unlikely to move any time soon. However, even with the tax-free interest provided by an Isa, these returns are still below the rate of inflation, meaning savers are actually losing money in real terms. Also, savers need to be aware of temporary bonuses offered on many of the products advertising the best rates, which after they disappear could leave rates looking pretty uncompetitive.
Savers can improve the return they get on cash Isas if they are prepared to lock their money away for a longer period. Rates of about 3 per cent a year are available for a one-year term and more than 4 per cent a year over five years. While the highest rates may appear reasonable, there is not a huge difference between shorter-term and longer-term fixed rates and so it may be sensible to keep some degree of flexibility and perhaps, if prepared to tie money up, clients should be looking at a one or two-year period. After all, rates are unlikely to fall much further from here and so they should not be unduly disadvantaged when they look to reinvest at the end of the term.
Even without interest rate rises, the returns from cash Isas will start looking better for clients if inflation falls in 2012 as many are expecting. It could be that savers start to see real returns from cash savings. However, there is an important caveat to this and it is that many cash savers are older clients whose own personal rate of inflation is likely to be greater than the quoted retail prices index or consumer price index. This is because these people are likely to spend a higher proportion of their money on items such as food and utilities, which tend to rise in price faster than the rate of inflation. This will make it more difficult for them to achieve a genuine real return from cash savings.
It is important for everybody to have some money in cash, even if it is just to cater for short-term emergencies or requirements. If clients hold money in cash it then makes sense to have it where they get a competitive rate of interest and pay as little tax as possible.
Limitation
It could be argued that there is limited benefit in having cash Isas when interest rates are so low. However, it needs to be remembered that the cash Isa wrapper will still be effective next year, the year after and further into the future. The more money that can be held in cash Isas, the greater the tax savings will be, especially when interest rates do start to rise again, which they surely will at some point.
