A stocks and shares ISA protects your portfolio from tax. For this reason, if you are serious about investing in shares, one of the best ways to do so in the UK is inside an ISA.
ISAs are tax-efficient ‘wrappers’ created by the UK government to encourage saving. They are provided by all the high street banks, plus fund managers such as Legal and General, Fidelity, Jupiter, and specialist online brokers.
Every year you can put a certain annual maximum amount into a stocks and shares ISA, or put half into a cash ISA and the rest in a stocks and shares ISA.
The annual contribution limit for each year is detailed by HMRC, and it rises with inflation. The deadline every year for opening an ISA is April 5th.
Why open a stocks and shares ISA?
Most people only ever bother opening cash ISAs, which do offer tax-free cash savings. But stocks and shares ISAs can be even more useful:
- You can trade shares and receive dividends, all free of tax
- When you come to remove money from your stocks and shares ISA in years to come, you don’t have to pay any capital gains tax
- You can invest in all kinds of equities, including funds, index trackers, bonds, and individual shares
- You don’t even have to tell the taxman about your ISA transactions (and believe me, if you ever have to fill in a tedious capital gains tax form, you’ll fall to your knees with thanks that all your shares are in an ISA. Not all my portfolio is ISA-protected, and sometimes it hurts…)
Stocks and shares ISAs aren’t just for the rich
Perhaps because the market has been so volatile and overall returns poor for the past decade, many people think ISAs are a rich man’s concern, since very few have experience of paying capital gains tax, or even income tax on share dividends.
But modest savings can really add up to a big portfolio in a bull market, at which point the tax protection is invaluable.
For instance, John Lee, a veteran columnist in the Financial Times, put the maximum amount into PEPs (the forerunner of ISAs) from the moment they were introduced in 1986, and later filled his ISAs. A few years ago he revealed his total PEP/ISA investment pot had grown to over a million pounds!
I’d imagine Lee’s portfolio has shrunk a bit since then – whose hasn’t? – but it still proves the power of compound interest and the benefits of an ISA.
If you begin investing £7,200 a year into a stocks and shares ISA and enjoy average growth of 10% a year in your portfolio for 30 years, you will eventually have over a £1 million salted away to boost your retirement savings.
If you invested and grew that £1 million outside of the ISA, you’d have to pay £180,000 in capital gains tax to the Government!
Saving £7,200 a year is a lot for most people, but we all have to start somewhere. I’d argue even saving £100 a month will make a difference – and it’s worth starting early. Also remember that you can’t claim back ISA allowances in future years that you’ve missed once the April deadline ends.
Don’t wait until April – start your ISA savings now
Every year there’s a mad rush as people try to open their ISAs before the deadline. This is madness, in my view, for several reasons:
- For most people, trickling a regular sum of money every month into an broad index tracking fund held inside an ISA is the best way to save for the long-term.
- Start sooner and you’ve more time for your investment to grow
- As the market falls and rises, you’ll automatically benefit from pound/cost averaging, whereby you invest more when the market is cheap and less when it’s expensive
- Some even believe the seasonal ‘ISA rush’ drives up the price of shares
Equally, if you intend to invest directly in shares held in a ‘self-select’ stocks and shares ISA, now is the time to put the money in, when there are so many apparent bargains about.
Remember that you don’t have to invest money you put into a self-select stocks and shares ISA all at once. You can bide your time, as long as you do intend to eventually invest the money in equities.
ISAs sound much more confusing then they really are, so do read my previous post of ISA tips for more information about ISAs.
Best of luck if you do decide to take the plunge into the markets, and do make sure you know exactly what your portfolio is for in these turbulent times.