Why you should use your ISA allowance at the start of the tax year

For those who want to grow their money efficiently over the long-term, a stocks and shares ISA is a great place to start. ISAs always get a lot of attention at the end of the tax year, but the savvy investor knows it’s the early bird that catches the worm.

Best described as a tax wrapper that protects your money from the taxman, you can put up-to £20,000 in your ISA and all of the interest, income and capital gains generated can grow in your ISA tax free until you want to take your money out.

This is the main draw of the ISA. It’s a simple and tax-efficient way to grow your wealth over time.

There are many different types of ISAs – including Lifetime ISAs, Junior ISAs, and Innovative Finance ISAs – although the two main ones are cash ISAs and stocks and shares ISAs.

You can decide whether to put your allowance in one particular ISA, or split it across a few, although you can only open and put money into one type of ISA each tax year.

Should you have a cash ISA or stocks and shares ISA?

Both cash ISAs and their stocks and shares cousins play an important role in financial planning.

If you have a short time horizon or prioritise protecting the value of your money, a cash ISA might best suit your investor profile and goals. Unfortunately, inflation can silently eat into the purchasing power of your cash savings over time.

If you’ve saved up three months of outgoings, have paid off any expensive debt, and have a longer time horizon, you might want to make your money work harder for you on the financial markets.

Over the long-term, investing often outperforms cash. We recently took a deep dive into the potential difference in returns between a cash portfolio and a well-diversified stocks and shares portfolio, which threw up some telling results. 

Time is your friend

It’s easy to agonise over the best investment strategy to help you reach your goals and there are many habits designed to help maximise your returns. The one thing you really need is time.

Encouraging you to ride out short-term fluctuations, a longer time horizon allows you to take on more risk with your money in the hope that you’ll get higher returns.

Risk and return work together, so the more you want your money to grow, the more risk you need to take with your investments. The markets rarely get to their end destination in one swoop, there’s often short-term volatility along the way.

But riding these fluctuations out could be all you need to see your money go further. A well-thumbed research paper from asset manager JP Morgan highlights just how damaging missing the ten best days of performance can be on your overall return.

If you’d have invested in the S&P 500 in the two decades to 2014, you’d have made nearly 10% a year on average. Take out the ten best days and this performance slips back to just over 6%.

This highlights just how damaging trying to time the market can be on your investments. Although short-term volatility can make investors sell-out of their investments, the best performance can often follow these days of poor trading, leaving some investors out of pocket.

The millionaire regular investing plan

Investing £20,000 as a lump sum isn’t possible for everyone. But if you plan ahead and understand how much can you put in your ISA and contribute to it on a monthly basis, you could end the tax year with a strong investment portfolio that’s grown throughout the year.

Regular investment plans can take a lot of the hassle out of investing. You don’t need to decide when to invest and you don’t need to time the market. All you need to decide is how much you want to invest.

Not only is regular investing simple, but it can actually have financial benefits over time. By averaging out the price of an asset, you can lower the total amount you pay for it during periods of volatility – this is called pound cost averaging and we explain it in more detail below. The less you pay for an asset, the less the investment needs to grow for you to make a profit.

Below, we’ve outlined what you could have by investing in one of three regular investment plans for 30 years: £400 a month, £800 a month, and £1,600. This is a long-term investment, but the benefits are clear to see below.

We’ve assumed you will have invested in a balanced diversified portfolio with 60% exposure to equities and 40% exposure to bonds.

If you’d started invested in this 60/40 model portfolio in 1990 and continued to today, your money would have grown by an annualised 7.49%. We’ve assumed this rate of growth for our regular savings plans below, along with a more conservative 5% growth estimate.

Investing £400 a month

• How much you’ll have with 7.49% annualised growth: £422,000
• How much you’ll have with 5% annualised growth: £272,000

Investing £800 a month

• How much you’ll have with 7.49% annualised growth: £843,000
• How much you’ll have with 5% annualised growth: £545,000

Investing £1,600 a month

• How much you’ll have with 7.49% annualised growth: £1.7 million
• How much you’ll have with 5% annualised growth: £1.1 million

This could be a useful addition to your pension income, as there are tax charges if you contribute over your annual allowance, which is currently £1,055,000 for the 2020/21 tax year.

End of the tax year

As the City clears up from the celebration of the tax year-end and the ISA season winds down, investors fall victim to ‘out of sight, out of mind’, which could be diminishing the potential for returns.

Many will wait until the last minute to decide how to make the most of their annual tax wrapper, but investors could increase their scope for returns with just a little bit of forward planning.

Here are five reasons why you should get ahead of the game and start maximising your ISA allowance today.

1. Maximise tax efficiencies

The main benefit of an ISA is that your investments can grow tax-free. You won’t pay capital gains tax if your investments increase in value, and your income is also safe from the taxman – whether from dividends or bonds.

If you start investing earlier in the year, you stand to benefit from the tax-free returns for longer. However, as the annual CGT allowance is £12,300 for the 2020/21 tax year, this won’t necessarily affect all investors.

2. Maximise returns

The case for long-term investing is well established, and whilst a year is usually considered short-term, it’s a lot longer than the one month you’ll be invested if you leave it to the end of the tax year. This will give your investments more chance to grow, although the value of your portfolio can go up or down.

A diversified investment strategy looks to smooth out sector-specific risks by offsetting any negative performance with the positive. The earlier you start, the more opportunity your investments have to grow tax-free.

3. Get peace of mind

You either use the annual ISA allowance, or you lose it. Taking advantage of your tax-free wrapper earlier on in the year means you don’t have to worry about missing the deadline next April.

4. Hassle-free investing

Make your life simple. After signing your initial ISA declaration, you don’t have to fill in a tax return for your investments within your stocks and shares ISA.

At Moneyfarm, we do the hard work for you – matching you to an investor profile and portfolio that’s specifically managed by our experienced Investment Team to reflect your tolerance for risk. This allows you to focus on the important things in life.

If you have any questions about investing in your ISA, the investments in your portfolio, or would like a free external Portfolio Review, book a call with our Investment Consultants. They are happy to talk through how recent market events could impact your investments, and how your portfolio is positioned to maximise global investment opportunities and minimise risk. 

FAQ

What happens if I put more than 20000 in my ISA?

If you exceed the £20,000 ISA allowance, do not try and take it out of your account. Instead, contact HMRC, and they will reclaim any excess amount paid into your ISA account, but you will have to pay tax on any investment beyond the ISA allowance. If you are unaware that you have exceeded the ISA allowance, HMRC will contact you at the end of the tax year when they check your account record. 

Is it worth putting money in an ISA?

If you are going to save or invest your money, you might as well put your money in an ISA account for its tax benefits. Any interest earned in an ISA account is tax-free. You don’t pay income tax and capital gains tax. It is of mutual benefit for savers, and you get better rates of return when you invest in an ISA, especially in stocks and shares ISAs.

Can you have 2 ISAs?

You can have 2 ISAs. You can even have multiple ISAs. However, you can only open one per tax year, and you can contribute only contribute into one type of ISA account each year as long as you do not exceed your ISA allowance.