Who wants to be an ISA millionaire?

The rise of million-pound Individual Savings Accounts (ISA) portfolios in the UK reflects a growing opportunity for individuals to build substantial, tax-free wealth. According to the Daily Telegraph, Britain's largest ISA holdings stand at more than £11 million, which is testament to the benefits of favourable tax treatment and strategic investment growth within ISAs. In fact, according to HMRC data obtained by savings app Plum, the number of savers who have at least £1 million in a tax-free account went up by almost 20% between 2021 and 2022, with current figures showing that the UK now has 4,850 ISA millionaires. 

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So, what is the appeal of ISAs and how can you utilise the benefits, especially when it comes to tax efficiencies and long-term financial planning strategies.

Why are ISAs so popular?

ISAs provide a unique, tax-efficient savings and investment wrapper. Unlike many other options, both the gains and withdrawals from ISAs are entirely free from income tax, capital gains tax and dividend tax. This advantage becomes increasingly valuable as personal savings and capital gains allowances are reduced.

By contributing to an ISA annually, investors can compound their wealth over time without tax erosion. While there is an annual contribution limit of £20,000 across all ISA types (excluding Juniors ISAs where the limit is £9,000 a year), there is no cap on how much can be accumulated over a lifetime.

Why now is the time to prioritise ISAs

Following the UK October 2024 Budget, capital gains tax (CGT) rates were increased from 10% to 18% for basic-rate taxpayers and from 20% to 24% for higher and additional-rate taxpayers. Additionally, capital gains tax allowances have steadily declined in recent years, dropping from £12,300 to £6,000 and now to just £3,000. These legislative changes and the ongoing reduction in tax allowances highlight the growing importance of effective tax planning, with ISAs emerging as an essential tool for mitigating tax liabilities.

Key benefits of ISAs

Tax-free growth

• Any profits from investments held within an ISA are exempt from CGT and income tax, which is particularly valuable given the recent reductions in CGT allowances and increased tax rates.
• Interest earned on cash ISAs and dividends or interest from stocks and shares ISAs are completely tax-free.
• Withdrawals from ISAs are tax-free, regardless of the amount or the purpose of the withdrawal, providing savers with easy access to their funds without worrying about tax implications.

High Annual Allowance

• The annual contribution limit of £20,000 allows individuals to save or invest a substantial amount each year within a tax-free wrapper. Over time, this can lead to significant wealth accumulation.

Wide variety of Investment options

ISAs cater to diverse financial goals and risk appetites, offering a range of options:

• Cash ISAs: are available to those aged 16 or older if, at 5 April 2024, an individual is 16 or 17 and does not have an existing cash ISA, they will be eligible to apply for, and subscribe to, a single cash ISA in any tax year until their 18th birthday. 
  Where an individual aged 16 or 17 holds an existing cash ISA, they may continue to subscribe to it or transfer it to another cash ISA after 6 April 2024. With a contribution limit of up to £20,000 per year (shared with other ISAs). They offer low-risk, tax-free interest and are protected under the Financial Services Compensation Scheme (FSCS) up to £85,000.
• Stocks and Shares ISAs: are for individuals aged 18 or older, with a contribution limit of £20,000 per year. They provide the potential for higher returns and tax-free growth over the long term.
• Lifetime ISAs: are available to those aged 18–39, allowing contributions of up to £4,000 per year, with a 25% government bonus (up to £1,000 per year). These funds are tax-free when used for a first home or retirement, but early withdrawals for non-eligible purposes incur a 25% penalty.
• Innovative Finance ISAs: are open to those aged 18 or older, with a contribution limit of £20,000 per year. They offer tax-free returns from peer-to-peer lending but carry higher risks and are not protected by the FSCS.
• Junior ISAs: are savings accounts available to children under 18 in the UK, enabling parents, guardians, or others to contribute up to £9,000 annually towards the child's future. Offered as either Cash ISAs or Stocks and Shares ISAs, the funds grow tax-free and remain inaccessible until the child turns 18, at which point they gain full control, and the account automatically converts into an Adult ISA.

Inflation protection

• For long-term savers, investing in a stocks and shares ISA can provide growth that outpaces inflation, unlike cash ISAs, which may be vulnerable to erosion of value in a high-inflation environment.

Flexibility

• Flexible ISAs: Allow withdrawals and replacement of funds within the same tax year without affecting the annual subscription limit, making ISAs suitable for both short-term liquidity needs and long-term savings.
• Portability: ISAs can be transferred between providers without losing their tax-free status, enabling individuals to shop for better rates or investment options.

Complementary to other savings tools

• ISAs can be used alongside pensions or other savings vehicles, providing an additional tax-free resource to support long-term financial goals, such as retirement or homeownership.

Why Stocks and Shares ISAs offer greater growth potential

Stocks and Shares ISAs offer greater growth potential, especially in a high-inflation, low-interest environment where cash ISAs often struggle to outpace rising prices. Unlike cash ISAs, which can lead to real-term losses, Stocks and Shares ISAs provide access to higher potential returns through equities and other growth assets. The advantages of Stocks and Shares ISAs include tax-free compounding gains, allowing investors to reinvest returns and benefit from growth without tax implications. Additionally, Stocks and Shares ISAs provide stronger long-term growth. Historically, investments in the stock market have outperformed cash savings over time, making these ISAs a powerful tool for building wealth.

With the reduced CGT allowances and higher CGT rates, stocks and shares ISAs are particularly compelling as they protect all investment growth from taxation, thus offering a significant advantage over non-ISA investments.

The Additional Permitted Subscription (APS) rule

• An additional key feature of ISAs is the Additional Permitted Subscription (APS), which allows spouses to inherit their partner’s ISA balance, tax-free, as a one-time addition upon the partner’s death. This provision helps surviving spouses maintain and grow their financial wealth and is a vital aspect of estate planning.

How APS works:

• Eligibility: Upon death of an ISA holder the account becomes a ‘continuing ISA’. The surviving spouse or civil partner is eligible to inherit the ISA funds as a ‘continuing ISA’, in addition to their own ISA allowance for the year. This addition is one-time but can significantly help to boost the surviving spouse’s tax-free savings. The APS can be used for any type of ISA except for Junior ISAs, including cash ISAs, stocks and shares ISAs, lifetime ISAs and innovative finance ISAs.
• Application: To qualify for APS, couples must be married or in a civil partnership. The surviving spouse can apply for the transfer of their late partner’s ISA into their own. If there is no surviving spouse or civil partner, the benefits of the deceased’s ISA cannot be passed on. The continuing ISA   remains as it is until the earliest of the administration of the estate is complete, the ISA is closed, or three years has passed since death.
• Timing and Amount: APS transfers are based on the higher of the value of the ISA at the date of death or the value of the ISA at the date the ISA ceases to be a continuing ISA.  This ensures the ISA can always be transferred (as it is) into a new ISA. In some cases, the surviving spouse may even receive an additional allowance if the value is higher at the date of death. This sum can be added to the surviving spouse’s ISA, offering tax-free growth. If the deceased held multiple ISAs, the surviving spouse or civil partner can apply for a separate APS for each one.

How we can help

ISAs offer a highly tax-efficient way to build wealth, providing significant tax advantages. By understanding and leveraging the rules governing ISAs, you can integrate them into your financial plan to maximise growth and reduce tax liabilities effectively. With the guidance of a financial adviser, you can make informed decisions about which ISA options best suit you and or family's needs, helping you capitalise on their significant benefits. Overall, ISAs are excellent investment vehicles for anyone looking to grow their wealth tax efficiently and securely. We’re currently offering anyone with £100,000 or more in savings, pensions or investments a free financial review worth £500. Get in touch to find out more.  

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Investment returns are not guaranteed, and you may get back less than you originally invested. Past performance is not a guide to future returns.

This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The Financial Conduct Authority (FCA) does not regulate cash flow planning or tax.

The information contained in this article is based on 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.