Day of reckoning for Isas

Individual savings accounts - Isas - have reached a crossroad. The tax saving investment wrapper is about to lose one of its best-known plus points.

The government also plans to downgrade many other al lowances over the next few years. This leaves those with money to put by in a quandary. Should they bother with an Isa or just dismiss the whole thing as yet another way to suit the financial services industry's constant cash needs?

And with other schemes such as mortgage-linked endowments still in the doldrums, will homebuyers be able to afford to invest rather than reduce their home loan?

According to a survey from website Ample, 56% say the main appeal of the five year old Isa scheme is tax saving. Ample says investors want to know what is happening in the long term - 77% say Isa involvement is all about planning for retirement. They want the government to say Isas will last beyond the 2009-10 tax year after which all bets are off. The main difference after the current tax year ends is the disappearance of the 10% tax credit on shares and equity funds including investment and unit trusts.

There is no longer any direct Isa income tax advantage for basic rate payers - those on the higher rate will continue to gain, although less than before.

"The disappearing tax credit was always there in the original legislation," says Tony Vine-Lott, who runs PIMA - the Peps and Isa Managers Association, a trade body. "The change will also hit charities."

PIMA tried to lobby the government for a tax relief stay of execution.

It failed. But Mr Vine-Lott argues that the tax change should not deter anyone from investing.

"The equity Isa still has advantages over other ways of buying the same underlying investment," he says.

These include:
· advantages if the Isa owner became a higher rate taxpayer - more and more are being dragged in each year

· easy tax-free switches between trusts, especially when bought from fund supermarkets - you can move from equities to bonds and vice-versa

· no need to report the holding to the Inland Revenue or count dividends for tax returns

· no capital gains tax on profits (although no relief on losses).

PIMA says full tax relief re mains for bond funds - and for any trust with a mixed equity and bond portfolio, providing it has at least a 60% bond content.

The Cash Isa still offers full tax relief both to basic and higher rate taxpayers. But the government wants the present £3,000 a year limit slashed back to £1,000 in 2006-07.

But while those who can afford to save should do so in an Isa first - whatever the tax allowance, it is a question of use it or lose it and many Isa deals are better value than non-Isa products - those who are watching their mortgage endowments value shrink, might be better off paying off their home loan.

This week two major endowment firms cut bonuses again - and warned of worse to come.

Friends Provident has halved the pay-out on endowments to 0.25%.

"We expect future investment returns at lower levels," says Friends' Ben Gunn.

At closed fund Royal & Sun Alliance, there is no cheer either. It is paying just 1% on most mortgage linked plans. Actuary Mike Kipling, told Jobs & Money: "Terminal bonus rates have been changed on several occasions during 2003 to ensure payouts remain in line with the profits earned."

Case study: Farmer reaps the rewards

Farmer Alan Slater has a story as rare as hen's teeth. He profited from an endowment mortgage. Now he has re-cycled those gains into Isas as part of a long term saving strategy. And taking a 15 to 20 year view, he is unconcerned about forthcoming tax changes.

"I obviously wish the tax deal on dividend income was going to stay. But I'm looking a long time ahead so am concentrating on capital growth rather than income. And it'll be tax free," he says. "You have to leave the money and watch it roll in. And don't try trading funds - you just chase your tail on costs."

Mr Slater, who runs a dairy herd in Shropshire, had a 20 year endowment with Royal & Sun Alliance which matured in 1999, multiplying his premiums five-fold.

"I needed to re-invest the money so that I could save for my retirement and also be able to use the cash - farming is an uncertain business. Isas suited," says Mr Slater, 46, who with his wife Ruth has an eight-year-old daughter Rebecca.

"I was determined to select investments on my own as I don't think IFAs earn their money. So I put money into investment and unit trusts, using Isa allowances where possible," he says.

His first Isa in 1999 was a Fidelity investment trust which split his money between the fund manager's Special Situations and European Values trusts - good choices as both survived the bear market in a healthier state than most rivals.

From then on, he has used allowances for both himself and Ruth, always making his own decisions and looking at the long term. He followed the Fidelity funds with unit trusts. But now he focuses on Foreign & Colonial, a global growth investment trust.

"This will never be top of the world but it is low cost and a convenient way of acquiring a global portfolio. I like the way investments trusts increase my involvement through borrowings. I think this will work in my long term favour," he says.

Play by the rules

Isas rules can be complicated - and if you get it wrong, the Inland Revenue can ask for its tax money back.

But if you stick to these rules, you won't go wrong.

· You have a £7,000 maximum allowance for the tax year ending April 5, 2004.

· You can put up to the entire amount into stock market investments. This is called a maxi-Isa and has to be with one fund house or with one "fund supermarket" wrapper.

· Alternatively, you can invest up to £3,000 in stocks and shares; up to £3,000 in a cash fund; and up to £1,000 into a special life insurance plan. These are "mini-Isas". A few firms have maxi-Isas with cash elements up to £3,000.

· The Isa is not an investment - it's a wrapper for investment and savings plans.

· The Isa label is not a guarantee of anything even if it carries the government CAT - Costs, Access, Terms - accreditation. Investors have to assess their own needs and the risks they want to take.

· The stock market Isa covers a huge range including funds such as investment and unit trusts focusing on anything from gilts to Japanese smaller companies. You can also invest in individual shares via an Isa.

· The cash Isa generally offers a higher interest rate than other bank or building society accounts. But although designed to encourage the less well off to save, once you make a withdrawal, the money cannot be replaced.

· The insurance Isa has never sold well - it is due to disappear in 2005-06.

· The Association of Investment Trust Companies has a free guide to Isas now and where they are going - phone 0800 085 8520 or www.aitc.co.uk. There is also a listing of investment trust isa "special offers." including no cost share purchases from many trusts.