ISA Tax Benefits: Benefits of Tax Free Allowance ISA
When it comes to making the most of your tax-free ISA allowance, there are some simple themes to keep in mind. Discover more on Fineco Newsroom
IN A FEW WORDS
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4 min reading
Making the most of your tax-free ISA allowance
When and how you use your tax-free ISA allowance can make a big difference to your outcomes. Ways to maximise the benefits of ISA accounts include investing early in the tax year and investing regularly to take advantage of pound-cost averaging.
If you’re ready to get serious about investing, making the most of available ISA benefits is a good place to start. You can save or invest £20,000 each year, with any income or gains on that amount tax free. With that in mind, using your tax-free ISA allowance in full every year, if your finances allow, can be one of the few easy ways to build wealth.
You don’t have to wait until the end of the tax-year
However, there is also a question of when you use it to realise the full ISA tax benefits. The tax-free ISA allowance works on a use-it-or-lose-it basis. As such, each year, thousands of people rush to top up their ISAs before the end of the tax year to make sure they don’t miss out. On the one hand, this is sensible because you should maximise your allowance use each year; on the other hand, you may want to consider investing a little earlier this tax year.
Why? It’s just maths. Although past performance isn’t a guide to future performance, over the past 50 years markets have gone up around 70% of the time. That means in seven out of every ten years, you could have an extra year’s capital growth and dividend income if you invest at the start of the tax year rather than at the end. Compound this over twenty years or more and it could make a significant difference, particularly when the ISA tax benefits are added. By investing one or more lump sums, such as a bonus payment or cash savings you don’t need access to in the next five year or so, both before and after the end of the tax year, you can get the potential benefit of tax efficient growth for longer.
Regular investing can mean pound-cost averaging
Investing regularly into your ISA means you buy at a variety of prices. Sometimes the market will be higher and you will get fewer shares for your money. Other times it will be lower and you’ll get more shares, which can then benefit from market growth. This phenomenon is called pound-cost averaging. It’s a way of balancing out the highs and lows over the longer term.
Investing on a regular basis also helps you develop good habits with very little effort. You don’t have to weigh up whether it’s a good or bad time to invest, you just set up a regular Direct Debit. Humans are notoriously bad at timing the market – our instinct to run with the herd counts against us. It encourages us to buy when everyone else is buying (and the market is high) and sell when everyone else is selling (when the market is low) – this is the worst possible way to approach investing.
Stocks and shares versus cash ISA benefits
Around three-quarters of ISA deposits still go into cash ISAs but they account for just under half of the total market value of all ISAs. The message is clear – it’s worth considering a stocks and shares ISA to make the most of your ISA tax benefits. Despite interest rates increasing cash ISA rates remain low at just 1-2%. It would require a pot of £100,000 before the income exceeded the tax-free £1,000 Personal Saving Allowance available for basic rate taxpayers outside of an ISA, and, unless rates change significantly, cash investors are unlikely ever to make a capital gain.
The tax benefits of a stocks and shares ISA are far clearer. As an example, just for illustration, if an investor holds £20,000 in an ISA, paying a 5% income, as a higher rate (40%) taxpayer, they’ll save around £400 tax in a year. That £400 can then be reinvested for capital growth and to earn dividends. Over 25 years, it could add around £1,400 to the investment. And that’s just one year.
The three simple themes to keep in mind
In summary, when it comes to making the most of your tax-free ISA allowance each year, there are some simple themes to keep in mind: invest early where possible, invest in the stock market and invest regularly. This is likely to be the best path to growing your wealth over time.
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