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‘Tis the ISA season

With the end of the tax year just around the corner, ISA season is upon us. This phrase seems to pop up frequently around this time, but you may be wondering what exactly it is and why it happens at this particular time?

As we approach April each year, there is a financial marketing rush whereby savvy financial institutions target campaigns encouraging customers to make use of Individual Savings Accounts before entitlements for the year run out. 

An ISA is a way of saving and investing money which is exempt from tax. April 5th is the deadline after which the year resets and you will lose any allowance you have not used. The threshold is currently set at a maximum of £20,000 per person per tax year for those who are eligible to open an ISA in the UK. Following on from our latest blog post discussing financial resolutions for 2021, this month we focus on the benefits of using your ISA allowance in order to take control of your financial wellbeing . 

We encourage you to get ahead of the game and avoid the unnecessary panic before the deadline to ensure you are making the most of your allowance. If you are uncertain about where or how to start, The Wealth Consultant can introduce you to the right person to help consolidate your ISAs.

What is an ISA?

ISAs are like normal savings and investment accounts, but they are “wrapped” in a tax efficient wrapper meaning you do not pay any income, dividends or capital gains tax on your contributions. There are currently 4 types of adult ISAs and 1 junior ISA to choose from. ISAs are an excellent way of growing your wealth in a tax efficient manner, providing you understand the rules and regulations for the different types. Data from HM Revenue & Customs shows that in 2018-19 around £67.5 billion was subscribed to Adult ISAs, a £2.3 billion increase from the year before. Your £20,000 allowance can be spread across different ISAs or it can be held all in one. However, you are only permitted to have one of each type of ISA. 

What types of ISAs are there?

There are a number of different ISAs to choose from:

  • Cash ISA
  • Stocks & Shares ISA
  • Lifetime ISA
  • Innovative Finance ISA
  • Junior ISA

You can put money into one of each kind of ISA each tax year. ISA.co.uk takes you through all the different types and the rules and regulations for each.

ISA vs SIPP?

ISAs and SIPPs are both tax efficient ways of saving for the future but there are some key differences. With an ISA, contributions are made net of tax, and as such you do not pay tax on gains or income earned within that ISA. Conversely, contributions into a SIPP are made gross of tax, attracting tax relief of 20%, or 40% if you are a higher-rate taxpayer, which is essentially a government top up of your pension. Tax is paid when you start to draw down your SIPP in the form of income tax. Unlike ISAs, you can contribute up to 100% of your earnings into your SIPP, capped at a £40,000 annual allowance.

SIPPs are designed to be long-term investments and you will not have access to your pension pot before the age of 55. Once you reach 55 you are eligible for a tax-free withdrawal of 25% of the value of your SIPP. You can choose to either withdraw it as a lump sum or stagger withdrawals. With an ISA there is no limit on how much it can grow, whereas a SIPP has a lifetime allowance of £1,073,100 after which, you will be subject to a tax charge. It is worth noting however that the lifetime allowance has been subject to regular change by HMRC over recent years. 

SIPPs may be more appealing to those looking for a long-term investment solution, but ISAs are frequently chosen for their flexibility. However, you do not have to choose between the two, many investors choose to have a mixture of savings across both ISAs and a SIPP. If you are unsure how to maximise their benefits for your personal situation you should seek the advice of a Financial planner or wealth manager. The Wealth Consultant can help introduce you to an appropriate advisor depending on your specific needs.

Why take advantage of your annual allowance?

Use it or lose it

You have up until midnight on the 5th April to fully utilise your tax-free allowance. After this, you cannot take any allowance leftover into the new tax year. For example, if you have invested £15,000 into a stocks and shares ISA and you do not use the rest of your allowance, you will lose the opportunity to invest the £5,000 tax-efficiently this tax year. By not taking advantage of your full allowance, you could be missing out on opportunities for significant growth.

Time in the market, not timing the market

After historically low interest rates, cash ISAs do not seem the most prudent way to be treating savings. Data shows that if you are looking to invest for the long run, a Stocks & Shares ISA could be far more beneficial than cash. Analysis from JM Finn suggests that if you intend to invest money for a long enough period to withstand falls in the market, the benefits of the stock market far outweigh the returns from cash. 

Given the current economic climate, people’s attitudes to investing have been reserved and have tended to opt for cash ISAs for fear of another market crash. However, your assets will be able to withstand small dips in the market and will eventually reap much higher rewards once you have given your money a chance to grow.

There is the hotly debated question of whether it is better to invest your money as a lump sum or stagger it across smaller investments. Forbes demonstrates that it is not about timing the market but time in the market. Attempting to beat the market is notoriously challenging and will almost always never work. If you get it wrong, you are subject to significant losses and will inevitably miss out on opportunities for potential gains. Tilney shows that spending time in the market is far more likely to give you good returns over the long term. 

ISAs allow you to invest small and regular amounts which will still add up to a significant pot in the long run, a process known as pound cost averaging. This method will make you a disciplined investor and will cushion losses from market drops. Charles Stanley Direct emphasises that whilst this approach may offer smaller rewards, it carries much less risk; you can still build a sizeable sum over time by investing small amounts regularly. Additionally, regular savings are flexible so you can stop or start them as you wish or change the amount. 

Transfers are possible

If for some reason you are not happy with your current set up and you feel you can get a better rate, it is possible to transfer money into a different ISA. Transfers can be made into a different type of ISA or into an ISA from a different provider. There are certain steps you need to take but as long as you are aware of the different transfer rules, money can be transferred easily if needed. Transfers will also not affect your current years allowance.

Sooner rather than later

Now is a good time to get ahead of the game and ensure you are getting the best possible deal from your ISA. The more prepared you are, the more money you will save in the long term as you avoid significant amounts of tax. Wealthify suggests making use of your ISA allowance as soon as the tax year starts to give your money the best chance to grow. With ample time on our hands during lockdown, it is a valuable opportunity to make more out of the money you have. You will only be helping yourself if you take the time to plan ahead and consider your options. 

Get started

People are often mistaken about the complexity of ISAs and their rules. Do not let the rush put you off making the most out of these tax wrappers. If you plan to continue building your savings and investments, ISAs will protect your assets from tax in the long run. This may all sound rather complicated and overwhelming. Wealth managers can clear up any confusion you may have over your ISAs and assist you with consolidating them into the best arrangement for you. With that in mind, The Wealth Consultant is here to guide you through the process and ensure you speak to the right people to get your finances on track this tax year.

Written on Wednesday, February 3, 2021 on the subject of Blog