For 25 years Individual Savings Accounts (ISAs) have been a great way to invest and grow your wealth.
Up until the recent Budget they were virtually free of all taxes.
Whilst the Budget has changed the rules on Inheritance Tax, proposing that from 2026 shares in AIM stocks will receive reduced Business Relief, dividends and interest received in an ISA is still free from Income Tax and gains are still free from Capital Gains tax.
The only downside of an ISA is its fairly low annual allowance.
You can only invest or add up to £20,000 a year into an adult ISA.
This can be a problem for those with larger sums to invest who want to make it as tax efficient as possible but have yet to put much in ISAs and are not keen on pensions following more changes in the recent Budget.
It can take years to build up a large investment in ISAs and if you don’t have the money now, you’re missing out using ISA allowances as these do not carry forward like they do for pensions.
In this article we’ll discuss a great hack you can use to ensure you don’t miss out on using your ISA allowance even if you don’t have the money now.
Why you might need to build up your ISA allowance
Now you may be thinking, what’s the point in building up your ISA allowance if you don’t actually have the money to invest.
Well, you might not have the money to invest now but you might someday soon.
This could be through a variety of reasons. Some of which are highlighted below.
#1 – Future Inheritance
Is it likely that you will soon receive an inheritance, either through the death of someone close to you or by them wanting to make a gift to you during their lifetime to help them avoid Inheritance Tax?
#2 – Insurance payout
If you’ve been in an accident or suffered a critical illness, you may be due an insurance payout.
You might even be the beneficiary of someone else’s insurance payout on their death.
You may well need to invest this money to live off, especially if you lose a partner.
#3 – Downsizing
If you are selling a property, moving to a smaller house and releasing equity, you may want to invest this equity to ensure its purchasing power is protected and/or provides you with an additional income in retirement.
#4 – Selling or winding up a business
You might receive a lucrative offer for your business, or it may be time for retirement and you have a lot of cash still held in your business account.
#5 – Withdrawing the tax free lump sum from your pension
In retirement you may wish to take out your 25% pension tax free lump sum. Especially from age 75 following the proposed changes announced in the recent Budget.
This could potentially avoid large taxes on the amount if you died post age 75.
In all of the above scenarios you could be talking about pretty big amounts and therefore trying to squeeze this all into one year’s worth of ISA allowance at £20,000 is just not going to cut it.
If you don’t have a build-up of ISA allowance available, the majority of the amount you receive is going to be invested and subject to taxes.
Income Tax, Capital Gains Tax and Inheritance Tax rates on money outside a pension or ISA are pretty dire.
Ultimately this is going to reduce the level of income you can earn from the payout.
Using a Flexible ISA
The key to increasing your ISA allowance without having to invest all the cash right now is to use a Flexible ISA.
Flexible ISAs were introduced in 2016 and essentially allow you to take money out of an ISA and then put it back in without it impacting on that year’s allowance providing you do it in the same tax year.
For example, if you had already built up £10,000 in an ISA during the last tax year, in the current tax year you can now take out the £10,000. Before the end of the current tax year, you would be able to put £30,000 back in. The £10,000 you had previously taken out and £20,000 which is the new current year’s ISA allowance.
The key point to remember here is that you only need to hold all of the money inside an ISA on the 5th April to ensure that year’s allowance and any previous allowances are protected. You can then take it all out from 6th April and not put it back in until the next 5th April.
Again, as an example and assuming the annual ISA allowance stays at £20,000, you could:
- Input £20,000 into an ISA by the 5th April 2025.
- Take out £20,000 from the ISA on the 6th April 2025.
- Input £40,000 into the ISA on the 5th April 2026.
- Take out £40,000 from the ISA on the 6th April 2026.
- Input £60,000 into the ISA on the 5th April 2027.
- Take out £60,000 from the ISA on the 6th April 2027.
By the time you get to the 6th April 2027 you have essentially built up an ISA allowance £80,000 whilst only having the money sat in an ISA for around 6 days.
If you are a couple, then you could of course double these amounts.
Now, I know what you might be thinking. You still need the actual cash to deposit into the ISA to make these numbers work and yes you are right. However, here are just some of the ways you could make it work using other money not originally allocated for investing.
#1 – Using money you have previously lent to your limited company
If you have your own limited company, then at some point you may have lent the company money in the form of a director’s loan.
This is usually a tax efficient way to provide the company with capital and receive an income from the company.
If you have money sat inside the company that is not needed for a while then you could repay yourself some of the loan, place it inside your Flexible ISA for two days as per above and then take it out and lend it back to your company. Then repeat this in future years.
#2 – Using dividends from your limited company
Most limited company owners will take their income from their company in the form of dividends. To save accounting costs and admin paperwork you may choose to take your dividends as lump sums once or twice a year.
If you then use that dividend to live off, you might park it in a bank account and draw from it when needed.
Before parking this dividend payment in cash, you could place it into your Flexible ISA first making sure you use your current year’s allowance. Then take it back out for spending. You just need to make sure an amount equivalent to your built-up ISA allowances is sat in the Flexible ISA on the 5th April each year.
#3 – Cash savings allocated for spending or a rainy day
Similar to how you would use the dividends in the example above, if you are prudent and keep an element of your wealth in easy access cash accounts to cover say six months to two years’ worth of normal spending.
Again, you could use some or all of this money to temporarily place into a Flexible ISA to build up your allowances.
#4 – Allocate money to ISA first then pensions
If you make regular or one-off personal contributions to your pensions each year, then you could consider placing the cash in a Flexible ISA first.
Then once the money has been in the ISA on the 5th April, you could then use it to contribute to your pension.
This only works if you have already built up at least one year’s ISA allowance with other money otherwise you would lose the pension tax relief in the current tax year.
For example, in tax year one you contribute £20,000 from your salary into a Flexible ISA.
In year two, you take out the £20,000 from the ISA and contribute it to a pension. This grosses up to £25,000 inside the pension.
Before the end of year two you contribute £40,000 into your ISA.
In year three, you take out the £40,000 from the ISA and contribute it to a pension. This grosses up to £50,000 inside the pension.
Before the end of year three, you contribute £60,000 into your ISA.
In year four, you take out £48,000 from the ISA and contribute it to a pension. This grosses up to £60,000 inside the pension and is the maximum under the pension Annual Allowance rules.
You still have £12,000 left inside your ISA and need to contribute £68,000 into your ISA by the end of the tax year.
By year five you can take out £48,000 again from your ISA and pay into a pension which grosses up to £60,000.
By this point you have £32,000 in a Flexible ISA but you have built up a total allowance of £100,000.
You also have input £195,000 in gross pension contributions.
Overall, cash of £188,000 has bought you £195,000 in pension contributions and £80,000 in ISA allowance.
Now, clearly you need to have the cash or salary to make this work, but the same concept applies even if you are using smaller numbers.
Finding a Flexible ISA
Whilst a Flexible ISA is a great product, they are not that easy to come by.
Most stockbroker accounts like Hargreaves Lansdown, AJ Bell, Interactive Investor etc at the time of writing do not offer one for their Stocks and Shares ISA.
This is probably not a bad thing as you don’t really want to be investing your Flexible ISA money in the short term if you are only using it to build up your allowance for the future and will shortly take it back out again.
Luckily, again at the time of writing, there are quite a few high street banks that do offer a Flexible ISA including the likes of Barclays, Lloyds, Nationwide and Halifax.
It’s probably a good place to start with the bank you do your normal day to day banking with as this will probably be quick and easy to set up. Remember we are not after the best interest rate here as for the majority of the time the money is going to be pulled out of the ISA.
Be careful not to hold more than £85,000 with one banking institution though as this is the deposit protection limit. If you feel you are over this amount with one bank you may need to open a new Flexible ISA with a different bank in the next tax year.
A final key point is that if at any point you don’t fill your Flexible ISA with the cash needed to protect your built up ISA allowance then you will lose the previous years’ allowances and you will be back to starting with a £20,000 allowance.
This ISA hack is a tactic that helps you secure a win in the tax game. This government and most likely successive governments are going to need more and more of your wealth to fund their spending.
Every little tactic helps when it comes to defending against excessive taxation.
If you would like to stress test your legacy planning or even to get a plan in place then please get in touch for a free no obligation 15-minute call. We would be happy to review your position, explain where you stand and what you need to do to get the outcome you desire. We have created hundreds of happy and protected retirements over the years. This could be you too.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
