Five key points for this year’s Isa investors

The number of Isa millionaires with portfolios on investment platforms has nearly doubled in the past year, as surging stock markets boosted assets held in tax-free investment accounts to record highs.

Nearly 1,400 Isa millionaires — people with an Isa balance of £1m and more — were on the combined books of three big UK platforms in early February. Interactive Investor had 731, Hargreaves Lansdown 579 and AJ Bell 55. That’s up from 725 the year before.

The investors are a distinct group — older than the general population, with an average age of 70, investing consistently over time, with most having used the maximum Isa allowance since the vehicles were launched in 1999, and backing “growth” stocks, such as tech companies.

They are among the financially most successful of the 22m British adults who, as of April 2019, held around £584bn in Isa accounts, according to HM Customs & Revenue data covering both cash and investment Isas.

But could it be that their growth strategy — targeting stocks with capital appreciation rather than income-producing potential — is running out of steam, after delivering rewards for two decades?

Isa investors of all ages are starting to worry about recent falls in valuations of tech stocks amid general concerns that ultra-low interest rates may have inflated asset prices.

It is not just market wobbles that raise concerns. Potential changes to the UK tax system following the pandemic mean there has never been a more urgent need to maximise tax-free savings allowances.

FT Money presents five strategic points for Isa investors to consider as they navigate markets in the coming tax year.

Is growth running out of steam?

The combination of growth investments and a tax-free wrapper has worked well. When it comes to funds and investment trusts, platform data show the top 10 holdings of Isa millionaires invariably include a heavy bias towards tech.

Baillie Gifford’s flagship Scottish Mortgage Investment Trust is a top 10 trust holding for millionaires across all the three platforms mentioned above, powered by underlying holdings including Amazon, Tencent and Tesla.

Despite a stellar performance during the pandemic, shares in the trust have fallen more than 16 per cent in the past month, as rising US bond yields and inflationary fears spark a tech sell-off.

“The ability of investment trusts to gear [borrow] to enhance returns means they can give a portfolio a turbo charge over the long term — but this can also drag down performance further in volatile times,” says Moira O’Neill, head of personal finance at Interactive Investor.

Other popular trust choices across the three big platforms include other tech-heavy Baillie Gifford funds — the Monk’s Trust, Scottish American and Edinburgh Worldwide — plus Murray International Trust, Polar Capital Technology Trust, Alliance Trust and Fidelity China Special Situations. Isa millionaires also favour growth when it comes to the top investment funds, with Fundsmith and Blue Whale being two of the most popular.

As tech valuations totter, the older millionaires face a classic rich person’s problem — is now the time to take profits? “It really is the million pound question,” says Holly Mackay, founder and chief executive of consumer website Boring Money.

“Tech proponents would say it’s not a bubble, and that we should rethink sky-high valuations in light of how the world is changing. But plenty of really sensible people think we’re in line for a major correction.”

Personally, she has taken some profits. However, she accepts that investors who trim their holdings will have to “get over some serious Fomo” [fear of missing out] if tech’s growth spurt continues.

FT readers considering this dilemma should take account of their investment timeframe and other investment assets.

“If you’ve got a million pounds in an Isa, you’ve probably got quite a bit of money in pensions and property too,” says Laith Khalaf, financial analyst at AJ Bell. “You might feel you can afford to take a bit more risk with your Isa for longer.”

One practical step is taking a so-called “X-ray” of a portfolio to reveal the underlying mix of stocks and so highlight any concentration risk. “A lot of global funds have got double-digit holdings in Apple, Tesla, Facebook and the usual suspects, and when you look under the bonnet, people are often holding the same stocks in other funds, or even via direct holdings,” says Mackay.

Most UK retail platforms have an “X-ray tool” — if yours doesn’t, you could set up a test account with one that does and input your portfolio details.

In a few clicks, you can see how your portfolio is split between various sectors and regions, your exposure to large-cap vs small-cap companies, and any bias towards growth stocks, cyclicals (which tend to rebound when the economy expands) or defensives (such as utilities and supermarkets, which tend to weather storms better).

For those considering taking profits, the next quandary is reinvesting the proceeds.

Some evidence of a switch into value investing — finding solidly performing companies overlooked by others — is emerging in AJ Bell’s investor data, says Khalaf.

“The most popular stocks of 2021 so far include GameStop and Argo Blockchain, but we’re increasingly seeing value plays like National Consolidated Airlines and EasyJet, with investors hoping for a boost as foreign travel resumes,” he says.

As companies restore dividends, yields on income funds (including global equity income funds) are starting to tick up again, boosting their attractiveness — but nervousness about the UK’s post-Brexit economy has weighed heavily on UK-focused funds and trusts.

Investors who have faith in the recovery could be tempted by cyclicals, with some pundits predicting a commodities comeback. “Markets are already pricing in reflation — but it’s not a done deal,” Khalaf notes.

For now, it seems investors are placing their faith in fund managers. Platform data shows the popularity of low-cost passive funds is slowly waning in favour of pricier actively-managed ones.

One year ago, Vanguard, the US-based passive fund manager, accounted for six out of the top ten most-bought funds at Interactive Investor. Today, active manager Baillie Gifford accounts for six.

“It does feel like we’re getting into more of a stock picker’s market, but if the good active managers can’t outperform in more challenging markets, then I think they will face an existential crisis,” adds Mackay.

Using Isas for tax-free income

When it comes to the direct equity holdings of Isa millionaires, it’s a different story — the platforms’ top 10s are dominated by dividend-paying UK blue-chips. Royal Dutch Shell, BP, Lloyds Bank, GlaxoSmithKline and Unilever are among popular income stocks.

Those with chunky Isa holdings have configured their portfolios to generate the maximum tax-free income. Within an Isa, there’s no dividend tax, nor does income tax apply to withdrawals.

“A £1m portfolio yielding 4 per cent generates a tax-free income of £40,000 per year, which is a pretty comfy retirement, especially when you add in any income from state and private pensions,” says Khalaf.

However, wealth managers warn that while Isas are tax efficient for growing investments and generating an income, those with large holdings face the problem of inheritance tax.

“I consistently find that nobody wants to touch the money inside their Isa, but all they’re doing is sitting around waiting to be taxed at 40 per cent,” says Michael Martin, private client manager at 7IM.

Although Isa money can be passed free of tax between spouses or civil partners upon the first death, after the second death it becomes part of the estate and therefore within scope of IHT.

Protecting your Isa from inheritance tax

One answer is to invest in qualifying Aim shares which, if held for more than two years, are subject to business property relief (BPR) and exempt from IHT. There are platforms offering ready made “Aim Isa” portfolios.

Boohoo, the Aim-listed online fashion retailer, is the most popular Aim share and the third most-bought stock overall on Interactive’s platform. With a pandemic growth story, its shares have risen by 29 per cent the past 12 months.

However, Aim shares can be volatile and there is a risk that the chancellor could take steps to end the BPR advantage for investors in future.

“Anyone considering Aim shares needs to understand that you don’t just have to hold them for two years, but be holding them at the time of your death in order to qualify for BPR,” Martin says.

“If you’ve run out of all other options, the Aim route could be worth the risk,” he adds, giving the example of a 90-year-old client with a huge Isa portfolio which would have been subject to IHT on his death.

“He wasn’t going to live for seven years, but there was a good chance he’d live for two more. His children were in on the conversation; we switched into Aim stocks, he survived for just over two years and this saved his family 40 per cent tax. But be warned — these investments are not for the faint-hearted as they carry a much higher degree of risk, can be volatile and harder to sell.”

Martin has a far simpler idea — if you can’t spend the cash, give it away.

“So long as you survive for seven years, gifting large sums is a very tax-efficient way of recycling your own Isa into funding the £20,000 allowance for adult children or grandchildren, or the £9,000 Junior Isa for under-18s,” he suggests.

Those who can afford to fund the maximum monthly Jisa subscription of £750 per month from existing income won’t fall foul of current IHT rules. 

Generous grandparents should also remember that through a quirk of the system, 16 and 17-year-olds have a £20,000 cash Isa allowance on top of their Jisa. That’s an extra £40,000 to be rolled into a stocks and shares Isa alongside their Jisa funds when they reach their 18th birthday.

However, youngsters gain control of the account on this date: so spending some time teaching them about managing a portfolio would be very wise.

Using Isas to avoid capital gains tax

Across the wealth management profession, minds are focused on possible changes to capital gains tax. Before the tax year ends on April 5, advisers are carrying out client CGT reviews to check for potential liabilities.

Investments held outside an Isa or pension may be subject to CGT when sold, depending on the size of the gain and individual allowances.

One option to explore is “Bed and Isa” — essentially, selling down your holdings, settling any CGT liability, and then buying them again within an Isa. Depending on circumstances, married couples and civil partners can pool their CGT allowances (£12,300 per person) and Isa allowances (£20,000 per person).

By straddling the tax year’s end, it’s possible for a couple to invest up to £80,000 within Isas in the next two months (£20,000 each, either side of April’s tax year) offsetting gains of up to nearly £50,000.

“Changes to the CGT regime might not happen this year, but it’s unlikely the 20 per cent rate on equities for higher-rate taxpayers will ever be lower — and it’s entirely possible it could be higher in future,” says Martin.

Using Isas to build future wealth

Since the pandemic, the number of younger investors opening Isa accounts for the first time has surged.

Nearly one in 10 Isa investors got started in the past year, according to research by Boring Money. It found the three brands that young investors were most likely to have opened accounts with over the past 12 months were Trading 212, Moneybox, and Hargreaves Lansdown, which Mackay says “neatly matches the three types of Isa newcomers”.

She says Trading 212 appeals to more short-term traders; the robo-powered Moneybox app suits investors who want a simple way to get started, and Hargreaves — which has overhauled its social media marketing — appeals to those prepared to do some research and select their investments.

For the young, tech and ESG funds (environmental, social and governance) funds have strong appeal.

“These are both tangible investment themes with a good consumer story,” notes Mackay. However, she also worries a “green bubble” is building up.

As an investor who “rode the waves” of the dotcom boom and bust in the early 2000s, she is wary. “People are really buying into the green story, but if you look at valuations in this pocket of the market, it’s definitely something to approach with caution.”

Again, it comes back to the question of individual investors’ timeframes. With age on their side and decades to build up tax-free investment pots, those at the start of their investing journey can better afford to hang on for the ride. However, experts worry that a sudden correction could unseat new investors, causing them to sell and abandon investing for good.

Khalaf says that today’s millionaires have built up their Isa wealth despite being limited to a maximum £7,000 annual contribution for the first nine years that Isas were in existence.

“They have had to achieve an average 14 per cent annual growth on maximum Isa contributions to break through the £1m barrier,” he says.

Investing the enlarged £20,000 allowance over a period of 21 years, “they would need a much more attainable 7 per cent growth to hit the £1m Isa jackpot, assuming the allowance doesn’t change. That means the Isa millionaires of the future will be more plentiful, and younger.”

But should they stop there? “A million pounds today is enough to secure a comfortable retirement, but when you factor in inflation, in 20 or 30 years it may not be,” says O’Neill.

“If you’re young and starting out, ramping up the risk won’t make nearly as much difference as increasing your contributions over time.” In other words, the more you put in, the more, eventually, you should get out.