Better Business: ISAs with bite

The ISA has been transformed from a mild-mannered tax efficient savings wrapper into a caped muscle-bound tax buster, says Peter Hicks.

The ISA has come of age. On October 6, anyone who will be 50 or over by the end of the tax year could invest £10,200 away from the clutches of the taxman. That is £3,000, or 42%, more than was previously allowed and, from April 2010, all investors will enjoy the increased ISA limit.

The increase means that a couple can now shelter more than £20,000 in their ISA every single year and so can very quickly build a significant investment portfolio. At a time when most people are bracing themselves for tax rises as the Government attempts to balance the nation's books, this generous and quite unexpected boost to the ISA effectively transforms it from mild-mannered tax-efficient savings wrapper to a caped and muscle-bound tax buster.

The increase presents advisers with a bonus mini-ISA season and the opportunity to review clients' planned and existing investments to help them maximise their investment returns.

Of course, advisers need not be reminded of the power of the ISA, but in the public's mind, the ISA is often misunderstood and its status as the premier non-pension, tax-efficient savings vehicle is overlooked. The challenge for advisers will be to overcome that misunderstanding.

The stark choice for investors is to choose whether or not to pay tax. Outside an ISA, most investors will have to pay some form of tax on their interest, dividends, rent or capital gain - inside an ISA they do not. The difference this makes to the ultimate return to investors is phenomenal, especially when longer time periods mean the additional reinvestments are compounded. In effect, the ISA increases a client's return without an increase in risk or the amount they pay in fees for the investment.

Expressing this choice in numbers can help make the point. When calculating the impact of tax on different investors, in different taxpaying situations, holding different investment types, we found an ISA investor's return can be as much as 100% higher, sometimes more, than an identical investor using another wrapper such as an on- or offshore bond, or an unwrapped OEIC. This additional return is simply down to the different tax treatment of the same theoretical underlying investment.

When compounding is taken into account, and the impact of successive years of ISA investing too, the numbers really turn in the ISA's favour. Imagine a high-rate taxpayer with £50,000 accumulated in UK corporate bond funds outside the ISA wrapper over a period of ten years. This investor would be £14,000 worse off after the decade than they would have been had they chosen to wrap their investments in an ISA. This is equivalent to an 83% higher total return.

So what difference might the additional £3,000 allowance make to investors? According to our calculations, quite a lot. Sticking with the example of UK corporate bond investors, if they were to make use of the full additional £3,000 each year for a decade, and were able to achieve a total investment return of 5% per annum, their portfolio would be worth almost £40,000 on top of the existing ISA value after a decade. This additional portfolio value rises to more that £150,000 after 25 years.

If these investors are basic-rate taxpayers, over that 25 years, they are £20,000 better off for investing in an ISA. Higher-rate taxpayer are more than £37,000 ahead of the non-ISA investors; and 50% taxpayers are a considerable £45,000. Basic rate taxpayers achieve a 37% higher return for choosing the ISA; higher-rate payers will double their total return; and the 50% payer see a return worth 150% of the non-ISA investor.

Remember, the figures above apply just to the additional £3,000. The same powerful principle applies to every penny invested in ISAs.

At this point, if your clients still need convincing of the usefulness of the tax advantages of an ISA, I suggest they are beyond hope. If, however, your clients have bought the idea of an ISA, it is possible they will not have a spare £10,000 or £20,000 lying about waiting to be invested. In which case, a portfolio review may point to existing investments that currently reside in less efficient tax wrappers.

If this is the case, because the ISA allowance is lost forever at the end of each tax year, a switch from one wrapper to another is a serious consideration. Of course, a wrapper-neutral platform that allows investment funds to be sheltered in all the main structures without prejudice is of use to facilitate the switch.

Right now, not all of your clients are able to take advantage of the Chancellor's generosity - until the end of the tax year, only older ISA investors can. This means advisers need an easy way to identify which of their clients will have reached the age of 50 by the end of the tax year, in order to effectively and efficiently target the clients who will benefit most.

Again, this is where a platform can help. Certain platforms can facilitate the segmentation of an adviser's client records, sorting their details to create whatever groups are required.

Need to generate a list of all clients who are 50 before the end of the tax year with some of their ISA allowance remaining? No problem - the platform can do that for you in a few mouse clicks. The output of such an exercise, a well-refined list of clients to target, becomes a mini marketing campaign from which you can launch your raid on the Government's multi-million pound tax giveaway.