Make the most of an ISA, and you could become ISA rich

Traditional planning has tipped its hat to pensions being the main financial instrument for most people. And whilst this still rings true, the relative restrictions of pensions, and the market expansion of accessible investments generates options for those looking for a more flexible investment option. What is arguably at the forefront is the Individual Savings Account (ISA).

An ISA (cash, or stock and shares here, but there are other kinds) is a great planning tool to help meet your goals. Firstly, an ISA allows an individual to grow wealth tax-efficiently as there is no tax levied on interest, dividends or growth, and there is a broad range of investment options. Secondly, it adds great flexibility within any financial plan as it doesn’t lock money away until age 57 (like a pension) and you can take tax-free withdrawals at any time  except for some ISA products like a Lifetime ISA).

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Becoming ISA-rich

An ISA is a useful part of any financial plan, but how does one become ISA-rich? Well, firstly by taking advantage of compound interest or growth - Albert Einstein famously referred to compounding interest as the eighth wonder of the world. Secondly, by regular saving and self-discipline… the latter is particularly important for those younger and in the ‘accumulation’ stage of their life with many competing priorities.

Is an ISA only useful for those wealthy enough to invest large sums?

The short answer is no. Presently, £20,000 is the maximum amount an individual can put into an ISA per tax year (the ISA allowance). Those who are younger and/or have lower earnings may not have the ability to use this fully but time is on your side to benefit from compounding growth.

When considering saving for the future, it is important to balance access (when you might need the capital/income), tax (on the way in and on any withdrawals), and establish what is affordable. If a lump sum isn’t available a smaller regular contribution by direct debit can help to create a savings discipline. This means, alongside your pension, and perhaps your first home; up to 100% of your assets can grow tax-free. An ISA can help you build your wealth over the medium and long term but remain accessible should you need it – a key difference to pension savings or any capital tied up in your home.

I am approaching retirement, is it too late to benefit from an ISA?

An ISA remains a useful tool for an individual as they enter retirement as the tax-free withdrawals mean you can tax-efficiently provide yourself with a regular income or a lump sum for a special purpose like a holiday, property purchase, or gift. There is also no age limit when investing in an ISA so if you have the excess income you could continue to save.

An ISA is often used to provide a tax-free income on top up any pension income you may be receiving enabling you to manage the tax you pay in retirement.  Having various savings pots with different tax treatments may also be particularly useful if a large lump sum is required to avoid potentially significant income tax charges.

If not required to meet a current need, an ISA pot could be left to grow to meet any unexpected costs in retirement or potentially the costs of care in later life. Many individuals look to their homes to pay for care costs, and whilst this is possible, ISA savings provide an alternative option. You can pay for care in your own home and potentially avoid the need to sell your home or use equity release in your later years. 

How much could I be accumulating in an ISA?

Creating discipline and a savings habit is key to achieving future goals. To put this into some form of meaningful perspective we have looked into how much could have been accumulated if you have contributed the full amount to a cash ISA or a stocks and shares ISA since they became available in 1999. In reality, there are not many individuals who have done this, but crunching these numbers shows the potential benefits of saving or investing in an ISA today for the future.

First the cash ISA

If you had fully used your allowance in a cash ISA each year since inception (April 1999) until April 2022 you will have saved £201,520 in total. If you had earned interest equivalent to the base rate (far lower than the best rates available), then you would be sitting on approximately £216,110 as of 5 April 2022. 

Turning to the stocks and shares ISA

If you were comfortable taking some risk and this was appropriate to meet your specific goals, you could have saved £266,560 into a Stocks and Shares ISA from  1999 to April 2022. Using the global stock market (MSCI World index) and its annual returns over this period, this would have grown to approximately £782,976.

The difference in the amount saved and the final value for the stocks and shares ISA in particular shows the benefits of compounding and contributing regularly. And in fact, there are even cases of ISA millionaires. 

So, what about  those on lower incomes, or who cannot afford to make the full contributions? Investing £3,000 per year from  1999 until April 2022 would have equated to a total saving/investment of £69,000 with a final value of £81,096 for a cash ISA, and £244,278 for a stocks and shares ISA. Remember, this growth is tax-free, and any income or withdrawals are also tax-free. 

In comparison a taxable investment account, you would be liable to Capital gains tax (CGT) on any profit above the annual exempt amount (currently £12,300 for 2022/23 but reducing to £6,000 from 2023/24 then to just £3,000 by 2024/25) which would reduce the growth you would achieve net of tax. With the planned reduction in Capital Gains Tax annual exempt amounts, investing in an ISA has never been more important to protect your savings from tax. In a pension, a withdrawal above any available tax-free lump sum (usually 25%) will be liable to income tax at the point of access. 

And finally, none of this considers the merits of a coherent investment strategy.

Can I become an ISA Millionaire?

The ISA Millionaire theory uses the very same logic as the above: regular contributions tied in with the power of compounding. There are many studies that  look at how much you would need to put into an ISA, to reach age 65 and have saved £1 million. These studies make relatively simplistic assumptions on salary, ISA legislation, and growth rates, but ultimately, they show that it is possible, theoretically…

Adding a dose of reality to the theory invites the questioning of these assumptions, such as how realistic is it that my salary will increase year to year? And what about life events such as children, or perhaps redundancy? Whatever age you are, the affordability of ISA contributions at any given time will depend on what life throws at you and should be reviewed regularly.

Speaking to an independent financial adviser, to create a plan specific to your individual circumstances and needs can help to establish your priorities, and affordability when putting money aside to meet future goals.

What’s more, you may only be a ‘millionaire’ nominally i.e. before inflation is taken into account. If you are investing over an extended period, inflation can erode the real value of capital. Establishing and maintaining a risk-appropriate investment strategy, as long as you have an appropriate time horizon, can help to maintain the real value of your wealth over time. 

Should you have savings, ISAs or other investments that you would like to ensure are appropriately positioned to meet your specific goals, do get in touch with us and arrange a free initial consultation today.

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Please note: The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction. The information is based upon our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change. The value of investments can go down as well as up, you may not get back what you originally invested. The FCA does not regulate tax, estate or cash flow planning.