This thought piece explains why it’s so compelling to fill your ISA each year. The approaches discussed won’t be suitable for all readers! Please think about your own situation and get professional advice if needed.
Even on a good middle-class income, it’s not easy to fill your ISA. The annual ISA allowance – £20,000 per year per adult – is pretty chunky.
And that’s a shame, because the ISA is a near-peerless tax shelter.
Gains made and income received in an ISA are tax-free. They don’t use up other tax allowances. You don’t even declare them on your tax return.
The snag is the ISA is a use-it-or-lose-it allowance. If you don’t fund your ISA one year, then that year’s allowance is gone.
That is to say, there’s no ‘carry-back’ type option, in contrast to pensions.
Use it or lose it
Even with no investment gains at all, you can squirrel away £500,000 into ISAs over 25 years. Just by putting in the maximum of £20,000 annually.
Okay, so ‘just’ is doing quite a lot of heavy lifting in that sentence. You would be excused for not quite being able to rustle up twenty grand of post-tax spare cash, year in, year out.
Especially in the early years of your career when your earnings are low, or when you’re trying to save for a house deposit. Or when you’re servicing a mortgage or wanting to go on holiday, or paying the school fees. Or for the kids’ university.
Oh, and what about saving into your pension?
Suddenly that difficult year is looking like your whole career.
But then Great Auntie Mabel goes and dies and leaves you £500,000. (She bought a house in 1976.) It’s a shame you can’t just put that all into your ISA in one go, isn’t it?
Especially since a friend, whose Aunt Bessie gave them £20,000 a year conditional on it being kept in a cash ISA during her lifetime, got exactly the same inheritance. Only they get a tax-free income from it, in perpetuity!
Tax and spend
Let’s say you both invest your inheritance into corporate bonds paying 2.5% per annum.
Let’s also presume you’re both higher-rate taxpayers in your retirement.
Because your windfall remains outside of an ISA, you will have £5,000 less to spend from your inheritance every year than your friend:
- £500,000 * 2.5% * 40% tax = £5,000 tax
And since the ISA allowance is now effectively inherited between a couple when one of them dies, the ISA tax shield benefit could go on for 30 or more years. Which means the ‘cost’ of not being able to use that ISA allowance might be £150,000 (each).
And that’s all assuming no growth.
Yes yes, I know, you could be putting the inheritance into your ISA over this time, and at year 20 you’d have it all in there. My numbers are to illustrate a point.
Besides, perhaps you’ll get a second inheritance or a bonus or sell a buy-to-let, or some other windfall?
It all seems a bit unfair. It’s like the full ISA tax break is only really available to those who start out rich in the first place!
If only there was a way to carry forward all those unused years of allowance to later on in your life…
As I just alluded to, a later life windfall might not even be an inheritance.
Many people earn much higher wages in their 40s and 50s. Or they might cash-out equity in a business they are involved in. Or sell their Bitcoin.
Whatever the case, it would be nice to be able to shelter any late-life lump sum in the ISA that you couldn’t afford to fill in your 20s, wouldn’t it?
Well if you haven’t ‘banked’ all those decades of allowances, you can’t.
Should you borrow money to fill your ISA?
Borrowing to fill your is ISA is the classic business school solution to this conundrum.
Every year you borrow £20,000 and put it into your (cash) ISA.
When Auntie Mabel dies you’ll have £500,000 in your ISA and £500,000 of debt. Her money pays down your debt leaving you in exactly the same position as your friend.
Common objections include:
- Who’s going to lend me that sort of money?
- The cost of the debt will exceed income on the cash ISA. That makes this an expensive exercise for some uncertain future benefit.
- Shouldn’t I buy equities in the ISA for higher long-run returns?
All reasonable counters. Let’s get the last one out of the way first. You’re asking should you borrow to invest in risk assets? That’s a different question to the one we’re answering here. We’re just going to say ‘no’ (for now).
To answer the first two objections, we turn to our secret sauce – a devilish brew of Flexible ISAs and offset mortgages.
Your new flexible friend
Flexible ISAs enable you to withdraw money from your ISA, without it affecting your allowances, as long as you return it in the same tax year. In this case it is treated as not having been withdrawn at all.
The legislative intent behind this is to enable you to use your ISA cash to meet unexpected large expenses and then ‘return’ the money to the ISA.
But we don’t care about the intent here. We only care about how we can turn this to our advantage.
Fill your ISA every year
You can withdraw money on the morning of the 6th April 2021 – the first day of the new tax year.
As long as it’s back in the ISA by the evening of the 5th of April 2022, very nearly one year later, you’re in the clear, because you’ve returned it in the same tax year, haven’t you?
Of course, the next day you can take it back out, for nearly a whole year again:
And you can do this every year – ‘re-paying’ into the ISA all the previous years’ used allowances, plus this year’s, and then immediately withdrawing it all the next day.
We only need to borrow the money for one night every year – overnight between the 5th and the 6th of April.
Now we’re going to need to borrow an additional £20,000 more each year for that evening, which may present challenges.
And realistically we should get it there a few days early, as opposed for just one day. There are operational risks – think “computer says ‘no'” hiccups – when moving large amounts of money around.
Off and on again
But how will you borrow the money?
That offset mortgage, of course.
If you have an offset mortgage or a flexible mortgage (one that enables you to overpay and redraw funds at will) then you’re all set.
You’re simply going to draw the money down on the 5th, warehouse it in your ISA overnight, and then pay-back (or offset) the mortgage with it for the other 364 days of the year. It’s only going to cost you a few days’ interest.
True, you might need to start off by taking out a larger mortgage than you would otherwise require, in order to give yourself the borrowing capacity to fill your ISA. But since it’s an offset / flexible mortgage, you can do that and pay no more interest, since the extra cash will spend most of the time parked against your outstanding balance.
This is a completely reversible transaction. It’s not like contributing to your pension, say, where the money is locked away. You can stop at any time if you need to, and let your ISA allowance lapse.
And it’s a very low-cost option.
Variations on the theme
This is just an idea. Do with it what you will. And yes, there are many real world frictions.
But it doesn’t have to be all or nothing – and you don’t have to do it for 25 years.
Maybe you only do this with a portion of your ISA, because you can afford to save some money from your income, too? You borrow to top-up the rest.
Or it could be as simple as avoiding the difficult decision of whether to use your bonus to pay down your mortgage or use up your ISA allowance. Do both!
Perhaps you could do a 0% transfer on your credit card balance, free up a bit of cash for a few months, and use it to fill the ISA allowance this year.
Business owners may be able to borrow from their business without tax implications if it’s within the company’s fiscal year (a reason for not having a April 5th end-of-year).
Crypto bros can DeFi borrow against their Bitcoin for a few days without triggering capital gains tax on their BTC.
You get the idea.
What about pensions?
The pension annual allowance is another, somewhat, use-it-or-lose-it allowance. (Only ‘somewhat’ because there exist carry back / forward arrangements).
But you can’t get access pension money very easily, so borrowing to fill it is a very different proposition.
However, there may be edge cases where it’s worth considering, such as if you’re a 60% tax payer (earning £100,000 to £125,000) on the eve of retirement, and a long way from the Lifetime Allowance.
The point is to be – cautiously and legally – creative.
Nobody else is better at looking out for your money than you are!
If you enjoyed this, you can follow Finumus on Twitter or read his other articles for Monevator.
It all sounds to me too much like ‘a wizard wheeze’.
I rather prefer the option whereby I increase my savings/investment rate. That is, increase the proportion of my income which is invested. And find savings in outgoings to cover for that.
Six years into a slightly early retirement, I can say that over the decades I’ve tried many wheezes. Generally I have found that those that require careful organisation such as this “borrow to fill ISA” might be good for a year or two, but quickly become a PITA and likely reduce flexibility for the next wheeze.
I’m currently reducing the number of bank accounts I acquired over the years; somehow I had 11 at the beginning of the year.
Too complex, too risky is my take. Interesting idea though, so looking forward to the next one.
The majority of investors are already doing this by virtue of having a mortgage – it’s just that they don’t treat the money as fungible.
I definitely have a larger mortgage than I need, because I have paid into my ISA many times and never voluntarily paid down my mortgage.
I don’t think the tactic described in the article would work for me, because I prefer to keep investments in the ISA and allow them to grow, but I have definitely allowed 0% credit card borrowing to move into my ISA to get it filled up more quickly.
Vanguard research has in the past demonstrated that investing quickly is the best approach, but I think for many losing the psychological benefits of DCA would be too painful.
I’m totally missing the point on this one.
You have a 20k ISA allowance. If you withdraw all your ISA balance then when you pay back in you can only pay back 20k in a year. If you transferred your ISA from say a cash ISA to a S&S ISA then you don’t lose the allowance for that year as it’s an ISA transfer.
If you are taking your cash ISA balance to zero every year then surely you can only put 20k back in? Where is all the huge compounding balance coming from?
Am I just being thick?
@Andrew Preston @Chiny
Disagree. CGT is a real thing.
The thing is the mistake you made not filling up your ISA one year only becomes obvious 20 years down the line when you face some big CGT bill when you look to sell something that has multiplied several times in value
I remember the site owner/Investor had exactly this issue last tax year with some FANG shares that had been held 15 years
Tax planning *is* generally fiddly and *does* involve thinking years in advance
But there actually are ten of thousands of people with seven figures ISAs out there that the tax man will never touch* so it is obviously worthwhile
*provide they convert them to AIM portfolios prior to death
However, whether it is right that this is happening is a whole other question…
Sounds reasonable @Finumus
The intent might be the test if this becomes a popular way of accruing a tax shelter and not really using it for the purpose government set out.
How might government react if, say, a lender of offset mortgages who was also a provider of flexible ISA’s decide to offer this as an automated service? I can’t see it being any skin lost for the provider and it may attract some juicy customers to an already attractive product for financially astute types.
The reaction from the government would be an interesting one.
You missed the word ‘Flexible’, and the explanation of Flexible ISAs, which mean so long as your money is in the Flexible Isa overnight on the 5/6 April, you keep the ISA status, and can build up the amount protected.
IIRC, other “use it or lose it” allowances (e.g. personal allowance, CGT allowance, savings allowance) offer planning opportunities under appropriate circumstances.
I remember your explanation of this on your blog, Finnimus – and have been employing it each year since as it strikes me as a potentially useful tool for avoiding the breaching the lifetime allowance on pension. My thinking goes like this: on minimum retirement age/when you look like you might breach it (whichever is later) – dump a tax free lump sum into an ISA and reinvest while keeping remainder of pension where it is.
@EcoMiser Ahhhh! That makes much more sense now. I’d not come across Flexible ISAs before. Thanks for helping me out!
So you are using the mortgage to bump up the available space in your ISA each year in anticipation of some big lump sum in the future that you can put into the ISA. With current interest rates, I’d think you’d rather leave the money in S&S ISA invested in low cost funds, and pay more interest.
I guess it’s useful to claim all your allowance if you can’t use it all or maybe your partner’s if you can’t find £40k a year between you to put in it.
Just don’t mess up!
@Half A Dent “I don’t think the tactic described in the article would work for me, because I prefer to keep investments in the ISA and allow them to grow”
If you can already comfortably fill your ISA allowance then it’s not exactly surprising that advice for people who can’t may not work for you 😉
For people who can’t pay mortgage, contribute to pensions, live, and still fill their ISA allowance the advice makes more sense. To give an example, my partner and earn decent incomes but after living expenses, mortgage payments, pension contributions, and other investments we have only been using about half our ISA allowance. Over 10 years that would be £200k of lost allowance. In the future we may be in a situation where we have an excess of available money beyond the current ISA contribution limit (for example the tax free pension lump sum, pension changes or hitting the LTA) and if we had used the technique outlined here we would have excess ISA allowance built up that we could use.
@John G, you write:
This may sound pedantic, but just a reminder that nothing on this site is *advice* as the term is used in the financial services world. We don’t know any reader’s individual situation, and even if we did we’re not qualified financial advisers. All articles are jumping off points for further thought and research. With this article in particular – which involves a bit of risky financial engineering, effectively — that’s even more true, as per the notice at the top.
@Neverland, you write:
A rare moment of complete agreement between us. Selling six-figures of unsheltered holdings have whalloped me with a big CGT bill coming due (and unnecessarily as it turned out, as Sunak hasn’t yet tinkered with CGT, though that risk wasn’t the complete story) simply because they’re outside of an ISA.
If I think about ISA tax shelters I was “entitled” to (huge air quotes there!) over my working life (but didn’t start filling until my early 30s) and the initial cost of those stocks, then in theory most if not all of it could have grown safely sheltered.
Of course my cashflows didn’t work out that way — on top of my initial foolish slowness to use up my ISA allowances — but that’s the point of this article.
And then there’s the paperwork:
@theInvestor – Good point! I didn’t bother to dwell on ‘why’ the ISA allowance is so valuable beyond the obvious tax savings. But… particularity in your dotage the lack of paperwork involved is a big win. This method of rolling your allowance gives you more paperwork today, sure, but possibly a lot less later, when you’ve been able to pack all your millions into an ISA, and not even have to put the gains/income on your tax return.
@JohnG – not sure why you’re misrepresenting my post in that way. I was saying that despite the core tactic described not being useful to me, I have done it in another way, as mentioned later in the article. You’ve just removed the latter part from your quote.
Great article, and thanks for your original Finumus article on this too. I will be making use of the Flexible ISA very shortly to fund a significant property purchase – it’s saving me from having to liquidate (unsheltered) investments. I will then fill the ISA back up with savings for the rest of the tax year and to the extent there’s an unused ISA allowance by the end of the tax year I will borrow over year-end to ensure that I roll over the rest. By the end of the 2022 tax year I should have filed my allowance back up again and I will have saved a ton of tax. Great result!
Curiously, the HMRC has allowed flexible ISAs but when I asked Youinvest if they did it or planned to, they said no. No reason why not, especially since other similar providers do offer a nice cash in cash out ISA service.
Which is a shame as I like flexiblity and sometimes need it but
A relatively recent Investors’ Chronicle article nas some info on how platforms may be waking up to flexibility in their accounts… May be of interest to some.
@The Investor – Not pedantic at all, I appreciate the rules you have to operate in and why they exist, sorry for the poor choice of word.
On a separate note, I tend to hesitate to take financial actions based on benefiting due to longterm access to ISA allowances. Maybe I’m overly cynical, but I just can’t see them surviving in their current form with the ability to shield such large amounts. For S&S it doesn’t really matter, but for cash style savings where ISA rates are so bad…
@Tom @Economiser. I’m with Tom on this, as I am not understanding the point. I suspect it might be that an obvious step has been left out on the assumption the “everybody knows that”
Is Finimus saying that once this flexible ISA twenty grand has been deposited then withdrawn, that it is somehow “registered” as being real? And that years later that registered ISA space can be filled with new money up to the twenty thousand pounds that was there originally?
This might help.
Not on topic but just a heads up 10am women’s’ hour, radio four, fire movement special today I hear
Sorry, not sure I get it either. It sounds like they’re “capturing” this year’s ISA allowance by borrowing 20k and then repaying it. In 10 years (say) they’d have a 200k ISA allowance – filled by (up to) 200k of offset mortgage debt. Surely that’s pointless if you don’t actually have 200k to put in?
Totally! However if you have expectations of a £200k windfall (inheritance, sale of business, tax-free pension lump sum, etc.) it makes perfect sense to capture the ISA allowance while it’s available.
In practice, you’re going to use part of the allowance in the normal way, and use this technique to preserve the remainder.
I think I have a real-world use for this trick. I will have enough in pensions and ISAs to retire early and buy a nice house ahead of that. I’d like to take advantage of the pension lump sum by using that for the house, so I can leave my ISA for income – that way I’ll pay less tax.
But I can’t access the pension until I’m 57, and I want to buy the house (and perhaps retire) a few years’ before that. So either I drain the ISA and then have a lump sum years later that is no longer tax-sheltered, or I have to take out a mortgage and pay interest for several years – whilst also having to guess how big the lump sum will be.
But now I think I can do the following when I buy the house: Transfer my ISA to a flexible one, take out an offset mortgage, withdraw the ISA cash to offset the mortgage, put it back in the ISA over tax year end, etc. Then, at 57, I take whatever lump sum I can from the pension, and put that back in the ISA.
That way, I’ve met my original objective, whilst paying only a few weeks’ of interest on the mortgage. Have I missed anything?
This article is an excellent illustration of why ISA allowances are too high. It’s a tax break only the rich can take advantage of and it’s so large that it’s incentivising complex financial shenanigans.
The govt should never have raised it above £10kpa.
@DaveS Nice idea, using it to shelter the pension tax free-allowance might be applicable for quite a few people.
I’m also not getting this, when i read the rules about flexible ISAs it states the money needs to be paid back in THE SAME tax year. So not sure how it’s possible to pay £200k into an empty account 10 years later.
@Auric and others — Um, from the article:
So the money is repaid in the same tax year. 🙂
p.s. Whether this is all doable in practice would be more my question — and perhaps whether there’s a spirit versus letter of the law at the platform/regulator level?
Great article. Do you know which S&S ISAs are Flexible?
Does this still make sense in the face of the high inflation. The value of the Cash Isa is being outstripped by inflation. Is there any situation where this is still helpful. I am contemplating this strategy but sees that 5 years down the line the Cash Isa accumulated would have lost purchasing power. someone helps..
@CB my understanding of this particular approach is to enable you to “reserve” your ISA subscription limits without having to notionally fill the ISA for the entire year.
For the past several years I’ve been making extra pension contributions as I had some carry forward allowance to use up. This tax year I don’t have sufficient direct cash flow to fill both my pension and my ISA. I’ve concentrated in my pension due to it being paid from non taxed income effectively.
However, I don’t want to miss out on a year’s ISA subscription and I have access to an offset mortgage with sufficient funds in it. If I open a flexible ISA in this tax year I can transfer funds from my offset mortgage into my newly opened flexible ISA and I’ve been able to use this year’s 21/22 tax year allowance. As soon as the next tax year starts I can take the funds back out and into my offset mortgage which will not cost me much in interest. In the 22/23 tax year I should have sufficient cash flow to fund my ISA fully.
If I withdrew funds from my offset mortgage and put them in my 21/22 Stocks and Shares ISA instead I will not be able to get those funds out again easily as that ISA is not flexible.