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Why use your ISA allowance?
The humble ISA is your financial Swiss army knife because it is so flexible and can be used in lots of different scenarios. However, it is often overlooked. Much like more complex financial instruments, the simple ISA can be misunderstood.
Why are ISAs so important?
Tax – Any growth received is very tax efficient and whilst there are some other investment wrappers that allow tax efficiency within the investment itself, once encashed it is only the ISA which has no liability for capital gains or income tax during the account holder’s lifetime. The below table compares a few other investment options.| Product | Income Tax | Capital Gains Tax | Inheritance Tax |
|---|---|---|---|
ISA | N/A | N/A | ISAs fall within your estate for inheritance tax. |
Pension | Most pensions offer an element of tax-free cash but after that, you will pay income tax at your highest marginal rate on any withdrawals. | N/A | N/A |
Cash savings | You may have allowances various available to you e.g. personal savings allowance and starter rate band. After that, any interest received is taxed as income at your highest marginal rate. | N/A | Cash falls within your estate for inheritance tax. |
Unwrapped Investments | Any dividends received could be taxed as income at your highest marginal rate of dividend tax. Depending on your circumstances, you may have a dividend allowance available. | After your annual capital gains tax allowance you will have to pay tax on any gains on the sale of your investment. | Unwrapped investments fall within your estate for inheritance tax. |
Secondary property investments | Income received in the form of rent is taxable at your highest marginal rate. | After your annual capital gains tax allowance you will have to pay tax on any gains on the sale of your investment. | All property falls within your estate for inheritance tax purposes. |
Flexibility – you can access your ISA whenever you need it. There are no tax consequences on capital received from your ISA. There are also no restrictions placed on you for future investments into your ISA. When completed in the right way you can also transfer ISAs keeping the tax efficient environment.
Use it or lose it – each year you are given an annual ISA allowance of £20k. If you don’t use it, you lose it.
Start small – whilst you can lose your annual allowance if you don’t use it, you do not have to use it all. You can start with small lump sums or a direct debit that is affordable. If in future years you have enough disposable capital, you can then add to your ISA in full for that year.
Real world scenario’s:
Retirement – most people think of their pension as their retirement pot and whilst that might be the case, remember that pensions are also exempt from inheritance tax. If you had another investment wrapper that was flexible and could provide withdrawals free of capital gains or income tax, you could use your pension later in retirement with the view to passing it on to your children. Your ISA is perfect to provide an alternative income in retirement.
Big expenses – buying a house, car, gifting to your children, a big holiday… these are all examples of ways you might want to use your ISA. If you were to take this from another investment there may be tax or future restriction considerations.
Summary – your ISA can provide tax efficient pot of money with no withdrawal restrictions for you to enjoy. Your future self may be grateful for any savings you put into an ISA as you can use it to spend freely and help achieve your future goals.
Written by Chris Hanbury DipPFS
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.
