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 [1] – £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 [2]?
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?
Gimme shelter
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.
Voila!
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 [3] 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 [4].
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:
[5]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 [6].
The point is to be – cautiously and legally – creative.
Nobody else is better at looking out for your money than you are!
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