The tax-efficient way to invest
For more than 20 years, ISAs have allowed us to save and invest tax efficiently. Although the coronavirus has had a dramatic impact on financial markets, it’s important to carry on using your allowances as we all look forward to better days ahead.
The Individual Savings Account (ISA) is one of the most straightforward ways to achieve tax-free gains. Unfortunately, people often leave it to the end of the tax year to think about their ISA but it’s a good idea to get in early. By putting your money to work at the start of the tax year, your investments will benefit from the tax advantages straight away, boosting returns over the long term.
The ISA celebrates its 21st birthday this year, and over that time the annual allowance has risen steadily from the initial £7,000 to £20,000 today. That higher allowance means an even greater difference in the potential tax-free gains from investing earlier in the tax year rather than later.
The maximum amounts you can invest through all adult ISAs are unchanged for the 2020/21 tax year (see table on next page). However, the Junior ISA allowance has more than doubled from £4,368 to £9,000 (see box ‘A head start in life’).
An ISA is a tax-free wrapper. You can hold various types of savings or investments within this wrapper, each designed with a different purpose in mind. The wrapper just keeps what’s inside free of tax. There are cash ISAs for savers, stocks and shares ISAs for investors, Lifetime ISAs for those looking to buy their first home, and Junior ISAs for those under the age of 18.
With interest rates on cash deposits being generally below inflation at the moment, cash ISAs may not be the best way to make use of your allowance. Below-inflation rates mean the real (inflation-adjusted) value of your savings would be eroded over time.
While a stocks and shares ISA involves more risk, it gives you the opportunity to earn a higher return than cash over the long run, with the flexibility to manage that added risk through diversification. The tax advantages of an ISA can give those returns an extra boost.
Whichever option you go for, the key to maximising investment returns over the long term is to use your full allowance every year and then leave it alone. You may be tempted to withdraw from your ISA account to pay for a holiday or home improvements, but once you spend the capital it will no longer be compounding those tax-free returns.
Raise the ceiling on your investments
If you’re working, a pension fund is still the most efficient way to save for later life, particularly if you’re a high earner. That’s because you pay in contributions from your salary tax free. However, if it looks like you might reach the £1 million ceiling then you’ll need to explore other places to save your money, such as ISAs.
An ISA also gives you more flexibility on the timing of withdrawals than a pension fund, which you can’t access until you reach the age of 55. When you reach the stage of planning how you will use your retirement savings, it’s important to think about where your income should come from. Which assets should you convert to cash first, and which should you keep untouched for longer?
Whether it’s putting your children through university or going on that round the world trip, investing in an ISA can help you achieve your financial goals sooner. Investing at the start of the tax year will help you get the most out of the tax benefits and compounding returns, but it’s never too late in the year.
Please speak to your investment manager if you’d like to find out more about investing through an ISA.