As the tax-year-end looms and people are thinking about last-minute planning for their ISA, here are 6 quick steps to make the most of your ISA pot.
1. Don’t be put off by Brexit
2. Take some risk
3. Get free Government cash
4. Put your income investments in an ISA
5. Reinvest dividends
6. Beware of charges
Laura Suter, personal finance analyst at investment platform AJ Bell, comments:
• Don’t be put off by Brexit
“Whilst it is understandable that people are worried about the uncertainty that Brexit and indeed other short term political dynamics are creating for stock markets, it is important to remember that there is a difference between putting money in your ISA and actually investing it. The annual ISA allowance is a use it or lose it tax break, you can’t roll it over to other years like you can with the annual pension or capital gains tax allowances.
“So if you have money you want to invest for the long term but want to wait until we know more about Brexit before you decide where to invest, make sure you get it into your ISA account before 6 April because you can then leave it in cash for a while before actually making any investments. Whilst you shouldn’t leave it in cash within a stocks and shares ISA for too long, it is absolutely fine for a short period of time and better than losing your ISA allowance which can be very valuable over the long term.”
• Take some risk
“Around 72% of ISA money is in cash, likely earning measly interest rates. Holding cash is smart, if it’s to meet short-term spending needs, as an emergency pot and if you want a low-risk investment. But if you’re willing to dip your toe into the investment markets you could make more money over the long term. Inflation is currently around 2%, which means you need to make at least 2% on your cash ISA account in order to just keep up with rising prices. The only way you can get that within an ISA at the moment is by tying up your money in a five-year fixed rate account, with the top easy-access cash ISA account only paying around 1.5%.
“The difference between cash and investment returns adds up over the longer term. Studies of long-term stock market returns show that they average around 5.5%, after inflation, so around 7.5% at the current rate of inflation. On a £10,000 ISA pot, after 10 years the investment would have grown to £18,771, assuming 7.5% annual return and 1% charges. In that same period the cash account with a £10,000 initial investment would have been turned into just £11,605. After 20 years the difference between the two pots would be £21,768.”
• Get free Government cash
“With the Lifetime ISA you can get up to £1,000 a year in Government bonus, up until the age of 50. If you opened a Lifetime ISA at age 18, that is a maximum Government bonus of £32,000 (or £33,000 if you’re lucky enough to have your 18th birthday before 6th April). The Lifetime ISA is open to those aged 18 up to your 40th birthday, and you can save up to £4,000 each year – either in one or more lump sums or as a regular monthly saving. From the age of 50 you no longer get the Government bonus but you can carry on paying into the account. You can withdraw ISA money once you’ve reached age 60 or to buy your first property, but be warned that if you take the money for any other reason you’ll pay a 25% exit penalty.”
• Put your income investments in an ISA
“The amount of dividend income you could receive tax-free was slashed from £5,000 to £2,000 last April. Any dividend income you get above this amount is taxed at 7.5% for a basic-rate taxpayer, 32.5% for a higher-rate taxpayer or 38.1% for additional-rate taxpayers.
“As the tax year ends people should make sure they put as much of their dividend-producing assets in their ISA as possible to avoid getting walloped with a tax bill. In pounds and pence, someone who receives £5,000 in dividends would previously have paid no tax but this year they will be hit with a tax bill of £225 if they are a basic-rate taxpayer, £975 for a higher-rate taxpayer and a whopping £1,143 for an additional-rate taxpayer.
“Assuming 4% income on your investments, anyone who has more than £50,000 invested in dividend-producing assets outside an ISA is likely to be hit by this cut. However, if you have this money in an ISA you won’t be taxed a penny of income tax on this pot.
“An investment pot of £100,000 that is yielding around 4% means that the investor will save £150 a year in income tax if they are a basic-rate taxpayer, £650 a year if they are a higher-rate taxpayer and £762 a year if they are an additional rate payer if this money was in an ISA rather than a normal investment account.”
• Re-invest those dividends
“Dividends received on investments within ISAs are free of any income tax so can be withdrawn with no tax liability. However, if you don’t need the income, reinvesting them to buy more shares in the same investment can have a dramatic impact on the size of your ISA fund over the long term.
“This is because when you buy more shares each time you receive a dividend, you then receive more dividends next time there is a payout, which can then be reinvested again and so on. Some investment platforms enable you to set this up to happen automatically.
“Let’s take the example of someone investing the full ISA allowance of £20,000 and assuming the FTSE All Share’s long-term averages of a compound annual growth rate of 5.5% and annual dividend yield of 3.5% a year. After subtracting 1% a year for platform administration and fund fees, the initial £20,000 will be worth £47,729 after 20 years. £21,834 would also have been banked in cash dividends, to give a total return of £69,563. However, an investor who reinvests the dividends rather than banking them would have £91,678 – more than £22,000 extra. The figures become even more attractive over longer periods.”
|
|
5.5% compound annual capital return only |
Dividends paid in cash (3.5% yield) |
Investment value + cash dividends |
5.5% compound annual capital return PLUS 3.5% dividend yield reinvested |
|
Initial investment |
£20,000 |
- |
- |
£20,000 |
|
After 10 years |
£30,896 |
£8,580 |
£39,476 |
£42,280 |
|
After 20 years |
£47,729 |
£21,834 |
£69,563 |
£91,678 |
|
After 30 years |
£73,733 |
£42,309 |
£116,042 |
£196,282 |
|
After 40 years |
£113,903 |
£73,940 |
£187,843 |
£420,240 |
Source: AJ Bell
• Beware of charges
“There can be a wide disparity between the charges levied by investment platforms and asset managers. The differences can appear small in percentage terms but over a long period, investment charges can have a significant impact on the value of your investment pot.
“The important point here is that higher charges are not necessarily bad if they are for a service or investment you value highly, but if you are paying more for something you don’t use or a mediocre service you could just be eating into your investment returns unnecessarily.
“For example, the UK regulator recently said that fees charged by investment platforms range from 0.22% to 0.54%. The cheapest active fund in the UK All companies sector is 7IM UK Equity Value with an OCF of 0.35% and the most expensive in the sector is Candriam Equities L at 2.34%.
“So, holding the cheapest UK all companies fund on the cheapest fund platform could cost 0.57% a year, whereas holding the most expensive fund on the most expensive platform could cost 2.88%.
“Assuming a gross investment return of 6% a year, on a £20,000 ISA investment, the difference in fund value after 20 years would be a whopping £20,612 (£36,973 compared to £57,586).”
