Amid the horror story that was the UK budget today [1], one bright spot stood out for those of us trying to save and invest our way to wealth.
The government is raising the annual limit on ISA contributions from £7,200 to £10,200.
Half of this ISA limit can be ‘wrapped’ around cash savings, just like today, with the rest (or more, up to the £10,200 limit) put into a stocks and shares ISA [2].
This means you can now save £5,100 in cash per year, tax free, or better yet use the ISA allowance to build up a long-term share portfolio.
I plan to use the full £10,200 limit every year to gradually shield more and more of my investments from tax.
The annual ISA contribution limit has only been raised once before in ISA’s ten-year long history, by a measly £200 last year, and early suggestions are the new limit will cost the Treasury a mere £20 million!
Most ISAs are used to save cash, and interest rates are very low meaning there’s not much tax payable. So it’s not the most generous gift savers and investors have ever seen.
Also, the new limit will only apply from April 2010, unless you’re over 50 (I’m not) in which case it starts this year. Nothing is ever simple with this government!
But after a long bear market [3], bank runs [4] here and abroad and plunging interest rates that have slashed savings income, it’s rare good news – so let’s not quibble.
How the £10,200 ISA limit can help make you rich
I believe ISAs are an incredibly important tool for UK investors, because of how they enable you to shield all capital and income gains on investments held in your ISA from tax.
Over the long-term this really adds up, particularly for the higher rate taxpayers most likely to use the entire allowance.
You probably won’t have to worry about capital gains tax [5] in your first few years of investing, but after a decade you could easily have a six figure portfolio, and from then on a good year with double digit returns could trigger a capital gain that you’ll either have to carry, pay, or try and defuse in later years.
Imagine how sick you’d feel paying 18% to the Revenue simply because you didn’t take out a cheap ISA wrapper years before.
Conversely, a £10,200 allowance might sound modest to some wealthy readers, but for most people on middle-class incomes who are accruing savings over a lifetime, it’s a very handy allowance.
John Lee, the Financial Times columnist, for example used the previous PEP scheme from 1986 and later ISAs to grow a £1 million portfolio.
Unlike with pensions you get no tax relief on money put into an ISA, but you also pay no tax when you take money out. And you can withdraw money whenever you need it, and spend or invest it how you choose – a valuable contrast to pensions.
Best of all, you don’t have to declare your investments held in an ISA when filling in a tax return. This can save hours of headache, although the simplified capital gains tax rules that came in last year [5] have made things much easier.
Why a £10,200 limit, rather than a round £10,000? It’s down to some thoughtful soul in the Treasury making the maths easier for those who pay into their ISA every month.
£10,200 / 12 = £850.
The ISA difference over 20 years
Let’s suppose the stock market delivers an average annual return of 8% return over the next two decades, which is well within the bounds of historical reason.
- Under the previous scheme, you could save £7,200 a year tax-free, or £600 a month. After 20 years at 8%, you’d have £343,596.
- Under the upcoming ISA regime, you’ll be able to save £850 a month. After 20 years at 8% you’d have £486,761.
A worthwhile difference: Fill your ISA wrapper under the new regime and you could accrue an extra £140,000 free of tax, according to this example.
Of course, average returns could be more or less than 8%. More pertinently, it’s down to us to find the extra £250 a month.
The government will enable you to save £10,200 tax free, but it won’t give you the money to do so!