Most of us know the story of David and Goliath – the tale of the young shepherd who defeated the veteran warrior with only his slingshot. An interesting story but could David have triumphed with one hand tied behind his back?
The introduction of Isas in April 1999 broke new ground. Central to the proposition was the stocks and shares element familiar from Peps, while the cash element from Tessas was also present. But there was a new kid on the block.
The inclusion of an insurance element in Isas met with mixed reviews. Some commentators thought it was progress, others pointless.
The majority view was that the David of the Isa world had a fatal flaw – an annual investment limit of £1,000 against the £7,000 limit for the unit trust Goliaths.
Many articles have been written on whether or not the £1,000 limit is appropriate. Is it sensible when the underlying investments are often the same as the stocks and shares element? Does it allow costs to be contained at a reasonable percentage level? Has it stopped a good idea before it really got off the starting blocks?
The £1,000 limit may be lifted at some point in the future but, for the moment, it is a fact of life. We can either moan and groan or accept the position and look for the potential benefits.
Peps did not permit with-profits investment but the insurance Isa has solved that problem. Investors can either put the whole of a £1,000 investment or part of a bigger investment into a with-profits fund.
If an investor is placing the full £7,000 in an Isa, then £1,000 into with-profits may not seem worthwhile. However, with-profits can form an excellent basic investment around which to build a portfolio. Product providers with strong funds, in particular, are worth considering.
In the case of regular-contribution Isas, the insurance element can be even more valuable. An investor saving £250 a month can put one-third in with-profits. They get a tax-free investment and do not waste any money on unnecessary and unwanted life cover (other than the required but insignificant 1 per cent of investment). This is a valuable proposition together with the fact that there is generally complete contribution flexibility without penalty.
Of course, to reap the potential benefits of with-profits, it is generally sensible to view it as an investment for at least five years. Over such periods, annual reversionary bonuses can be supplemented by terminal bonuses to raise the total return. With-profits funds are able to smooth returns over the longer term. Funds provided by financially strong providers generally hold a higher proportion in equities, giving the potential for better long-term returns.
The low maximum investment for insurance Isas has inevitably affected the money flowing into them. According to the Inland Revenue, in their first year, stocks and shares Isas amounted to £15.9bn, cash Isas £12.26bn but insurance Isas only £68m. This is significantly less than the potential one-seventh if all investors adopted an insurance element as part of their maximum-contribution maxi Isa.
Potential investors and their advisers need to consider charges when selecting an Isa and this is also true of insurance Isas. The Government has set Cat standards on these, too. In order to meet the standards, annual charges cannot be more than 3 per cent. In addition, minimum contributions cannot be more than £250 a year or £25 a month. The final requirement is that investors must be able to recoup all their investment after three years.
In effect, this is a security element which many providers have found difficulty in offering. As a result, many insurance Isas, like many equity Isas, do not carry the Catmark.
But this has not hindered equity Isas so why should it for insurance Isas?
The greatest potential benefit for insurance Isas is probably to treat the with-profits element as another fund choice within a maxi Isa. In this way, the client can benefit from having part of his overall investment in a smoothed fund enjoying the associated benefits.
Perhaps this David can never defeat its Goliath but why can't they coexist happily? Is that heresy?