In praise of the Flexible ISA

Flexibility is a good thing in an ISA. For most of their existence, ISAs and their forerunners PEPs were both use it or lose it tax-free allowances, and one way tickets. You could contribute money to an ISA, but draw it out and you lose the tax-efficiency of that contribution. Put 20k into your ISA in one tax year but draw 10k out, your allowance for that year is 20k-10k

Flexible ISAs make this work right. In the above example your allwoance for that year is still £20k, as long as the net contribution is made within one tax year. Here’s the Building Societies’ Association on flexible ISAs.

Most of the running about flexibility in ISAs is made about Cash ISAs, and the advantages are most obvious in cash ISAs. For most people, however, Cash ISAs are a waste of time, because you can usually get a better return on your cash/lose less of it to inflation with non-ISA accounts, because most people have a £1000 tax-free personal savings allowance on interest. Typical interest rates in the UK are up to 2%, so if you are using this allowance to the full you have about £50k as cash savings. That’s quite a lot – if you have that amount held as cash then you should ask yourself if you are allocating capital in your best long-term interest¹, although of course if you are buying a house or have a highly variable income then maybe that is OK.

I have a Charles Stanley Flexible ISA. Charles Stanley used to be a good option for modest sized ISAs up to about 50k, but they jacked up their charges about two years ago, to 0.35% of assets under management². I initially got this account because the platform fees were low at 0.25%, and it was a place to do funds³.

0.35% p.a. is not terrible, but it’s not great either. If I go to Monevator’s broker comparison table and run a sharpened claw down the end column Good For I discover  CS is basically good for… drum roll, expectant pause … nothing.

I’d like to push back on that. I carry this account at the moment because

Charles Stanley’s S&S ISA is good for flexibility

Monevator’s broker comparison table is probably complex enough as it  is. It performs a pedagogic role, too, and we shouldn’t be encouraging people to dip in and out of their S&S ISAs. If you don’t have an edge in the markets then buy and hold is the way to make money on the stock market, not churning your holding like Frankie.

But flexibility has its uses, particularly for those around the 55 mark. You can only get hold of money in a SIPP after 55. People aiming to retire before then will have to use ISAs as well. I’ve done the taxonomy of retirement stages around 55 in this post five years ago.

If you have built up a decent ISA portfolio by your mid fifties, it hurts to see that go down, all that tax sheltering goes down the toilet. A flexible ISA gives you a chance to keep some of that tax sheltering potential.

An Ermine is on the final approach to drawing my main pension. I am burning up my SIPP to zero ahead of that, but I still have an ISA. I am an early retiree, not an extreme early retiree. I stopped working in my early fifties. Someone pushing things to the limit would need to burn up their ISA to 0 by 55, where they could start drawing their SIPP. They can take a tax-free pension commencement lump sum, and in principle they could shift this into their ISA.

The glide path towards retirement is complicated by the limitations of tax-privileged accounts splitting your capital up into silos

Simulated drawdown of an early retiree starting with 300k ISA and 500K SIPP and spending 20k a year, effects of inflation and compounding not shown (it won’t help them much because they are drawing down over the period and accumulation is only 20 years). If you are going to retire at 41, ie be retired for half your life you need to start off with a lot of capital. You probably need a tad more, see RIT for the canonical lived worked example.

The anomalous peak at 55 is because this individual takes their 25% tax-free lump sum from the SIPP at 55 and reloads their ISA which has run out of puff at that point. They draw half their 20k spending from the ISA after this point and half from their SIPP to minimise tax on the latter, and at 67 when their ISA runs out for the second time they get 8k State pension.

A fly in the ointment is their PCLS is ~£130k, which would take over six years to get into an ISA at £20k/year. There’s a case for this individual to use staged crystallisation⁴, ie drawing out their tax-free money in 30k stages and pitching 20k of this into their ISA and using 10k to offset their spending, slowing their taxable withdrawal from the SIPP to keep under the personal allowance ⁵, avoiding paying tax on the SIPP. This way the money in the SIPP keeps working for them.

But there are other ways to make this work. One is using a flexible access ISA. I withdrew £20k from my CS ISA early this year. This of course means I am out of the market, but it is easy to do when valuations are high. It also means that if there had been a market crash last year I could have got back into the market. An added bonus is that I save paying CS 0.35%*20k = £70 in annual platform fees and in theory I could have stowed that in some high-ish interest current account. Life is too short to yomp cash through a bazillion current accounts although I did save some of this with Nationwide for some paltry interest.

At the end of last tax year I raised as much cash as I could from all sources, and put £17k back into Charles Stanley. This was tough as I’d contributed £20k to iWeb as well in that year, hence the shortfall. Cash reserves are low on the final approach to springing another silo, else you are doing something wrong – probably underinvested…

reserves are low on the final approach

There was a disturbing moment where Charles Stanley’s IT systems showed this as a contribution to the current year the money is put in, ie as if I had contributed £17k to them as well as £20k to iWeb, which is a no-no. However, I had asked CS first if this £17k would be considered a withdrawal from previous years’ funds and they said yes, I have this in writing. HMRC haven’t kicked down my door with hob-nailed boots for overcontributing to the 2018/9 ISA year. I got it in writing from CS, honest, guv.

anti-money-laundering woes

I withdrew this money a couple of days after the new tax year, and CS said they would refund the money to the debit card it came from rather than do it by BACS transfer which is the normal way you make withdrawals. This is because of anti-money-laundering regulations, apparently I stick out like a dodgy geezer. To wit:

Thank you for your instruction to transfer £17,000 from your ISA to your designated bank account. Please be advised that procedures issued by our Compliance Department state that all funds recently paid into an account by debit card cannot be transferred back out by BACS. Therefore, as you recently credited these funds into your account, I’m afraid I am unable to arrange for them to be transferred into your designated bank account by BACS. However, I can confirm that I have arranged for £17,000 to be refunded back onto the debit card that you paid the funds into your account with.

Initially I thought I would be stuffed and all this work to preserve 17k of previous ISA allowance would be undone. So I ‘fessed up to CS why I was doing this and they reassured me that I could make a contribution of £37k this year (£17k old allowance retained over the tax year plus £20k new ISA allowance). I have to return the £17k to this CS ISA but I can make the new 20k contribution to any ISA provider. This isn’t a huge restriction because I can transfer the cash amount from CS after putting the 17k into their system.

The obvious question is where is a mustelid going to find £37k this year when I could only drum up £17k last year. The answer is I have burned nearly all my SIPP into the ground and will draw my main DB pension only a little bit short of its normal retirement age. There is a tax-free pension commencement lump sum associated with that, and I’d like to get that into the ISA, please. This old allocation will help with that. Sure, for a couple of years I haven’t been invested to the tune of £17k, but it’s not like valuations are particularly low these days, so I gained more by deferring my main pension another year than I would expect in future income stream from a couple of years’ worth of the 17k working in my ISA. I even got my Brexit bung (that’s the only mention of Brexit in this post, 😉 ) on this money. The opportunity cost would have looked very different in early 2009.

Unlike with a SIPP, where the answer is simple – always take the maximum PCLS, if only to shift it into an ISA, with a DB pension it’s not always the right thing to do to maximise the PCLS, and I won’t. But as soon as I draw that pension, it is enough that I will be a taxpayer again until death, so it makes sense to draw bit more than the minimum PCLS, because I don’t want to needlessly pay tax on the income.

It’s much better to get flexibility from in your offset mortgage than your S&S ISA

I have to jump through all these hoops because I have no mortgage. This all goes to prove the old adage, for God’s sake don’t pay off your mortgage early in a time of low interest rates, but make sure you get a long enough offset mortgage term so that your income isn’t qualified⁶ between retiring and having your PCLS or other capital amount to pay off the mortgage.

But I was a berk and in a fearful place, so I paid off my mortgage before retiring. Dumbass. Monevator’s case against paying off the mortgage is still a good one eight years after it was written, because interest rates are still on the floor and not about to rise any time soon.

What financial institutions think of people with no income. Perhaps with greyer hair in the case of retirees

Once you have retired you are looked on as a hobo with your worldly belongings in a bindle in the eyes of the financial system, because everybody they lend money to has an income and wants to spend more than they earn. I asked a mortgage broker if I could get a mortgage when I moved and wanted to own both houses for a short while. FFS I owned the old house cash, and had more than half the capital towards the new place. The mortgage broker could neither understand nor help. In his world the only reason people wanted to take out a mortgage was because they didn’t have enough financial capital to make the purchase, but they had human capital in terms of roughly four times their annual income.

It is possible to have capital assets enough to last the rest of your life but to have a liquidity squeeze at a particular time. Early retirees need to be wary of this, and there are two resources they can draw down on. Their mortgage if any, and as a long second best, their ISAs.

Why second best? The opportunity cost of drawing down on an ISA depends on what the markets are doing. if they are at high valuations like now, the opportunity cost isn’t so bad. If they are at lows, like in 2009, the opportunity cost is ghastly and probably best not taken, you could give up a lot of your capital for liquidity.

You end up like this guy, except he’s already lost his and you are about to lose capital for the sake of liquidity

The loan is also only good for one tax year. There’s a lot wrong with using your ISA as your lender of last resort, but in the end if you have to, transfer some of your cash from a non-flexible ISA to a flexible ISA to use it. This is now Ermine battle-tested and it works. I suspect that the cost of providing flexibility means flexible S&S ISA providers are never going to be the cheapest for platform costs, so you only want some of your ISA with one of them. It’s not a great solution, but in Der Not frißt Der Teufel Scheiße…

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1. Although targeted at women, this Guardian article goes into the issues of cash as opposed to investing, the principles are general. Monevator has a good article on why do we invest, the context is that cash savings are not generally investing at rates of return typical today. ↩
2. You can check CS current charges here ↩
3. I use iWeb for shares and ETFs, because: no ongoing platform fees. ↩
4. You do not have to crystallise all your SIPP at once with some providers. You can take a tax-free lump sum in stages in this case. You should note that as soon as you take more than the tax-free lump sum from a pension you trigger the money-purchase annual allowance(MPAA) which means you can only contribute up to £4k p.a. to a SIPP for the rest of your life. ↩
5. The personal allowance in the UK is £12,500 at the moment, I have assumed £10k in the simulation to simplify the model. ↩
6. Above all else don’t take the piss like this retired accountant who discovers at 77 that you’re meant to pay off an interest-only mortgage and mithers at his MP that it’s so unfair ↩