It’s usually best to use your ISA allowance at the start of the tax year and in case you didn’t know, we have just entered a new one.
This will ensure you keep more of your investment return.
If you want to keep your options open then don’t worry, a recent ISA rule change means ISAs are now even more flexible.
What happens if you use your ISA allowance at the start of the tax year
A quick recap on ISAs.
ISA stands for Individual Savings Account and is a tax wrapper that can hold cash or stocks and shares.
Cash or shares held in an ISA can grow free of Capital Gains Tax and any interest or dividends produced from your ISA are also free of Income Tax.
So it’s usually a smart idea to use ISAs as an additional way (along with pensions) of saving for your future.
The only downside is that you are limited to contributing up to £20,000 per tax year. This is half the pension annual allowance (£40,000).
Now I am going to focus on stocks and shares ISAs in this article because unless you have found some magic cash ISA provider, the interest rates on cash ISAs are as about as low as they can get. So it really doesn’t make much difference when you use your allowance for a cash ISA.
For stocks and shares ISAs it’s usually best to use you ISA allowance at the start of the tax year. Here’s why:
- A year’s worth of growth is tax free. Leaving your ISA contribution until the end of the year could mean the money grown outside of an ISA will use up some of your precious Capital Gains Tax allowance. Especially when moving the money into your ISA from a general investment account.
- If your investment portfolio is more weighted to equities, which it should be for the more longer term investor, then any dividends earned from the general investment account (rather than an ISA) could be subject to Income Tax.
Whilst dividends on £20,000 could be small in monetary terms (for example £20,000 x a 4% assumed dividend rate = £800) if you make ISA contributions for yourself, your spouse and your kids. It could all add up.
How to use your ISA allowance at the start of the tax year
There are essentially two ways to use your ISA allowance at the start of the tax year:
- Investing it all in one go.
- Break it down into monthly/weekly investments.
If you are investing for the long term (10 years+) then it usually makes sense to get the whole allowance invested straight away.
Reasons why this might NOT be best for you could be:
- You have a low attitude to risk and prefer drip feeding your money into the market.
- You believe the stock market is priced high and feel a drop could be on the way.
- You feel you might need the money to spend in the near future.
Picking up on that last point. Rules for ISAs changed in recent years meaning that you can now take money out of your ISA and then put it back in again during the same tax year without it impacting on your ISA allowance.
Let me explain.
If you put £10,000 into an ISA this tax year but before the end of the tax year you took out £5,000, you could still pay in £15,000 before the end of this tax year. £10,000 left of your normal ISA allowance plus the £5,000 you took out.
BUT you need to ensure your ISA is a Flexible ISA as these are the only types of ISA that allow this. Please contact your ISA provider to check.
If you are someone using your ISA allowance by moving money from your general investment account then you don’t need to worry about monthly contributions into the ISA. It’s usually best to use your ISA allowance at the start of the tax year in its entirety as you are already invested, it’s just changing the tax status.
Finally, if you don’t want to invest right now you should still consider a cash ISA so that you are still using your ISA allowance. You could always transfer your cash ISA into a stocks and shares ISA at a later date.
Remember if you don’t use your ISA allowance in a tax year, you lose it.
If you want to find out more about your retirement options we recently produced a webinar on this exact subject. You can watch the recording below.
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.
