How to make the most of your ISA allowance before the 5 April deadline

There is growing speculation that the government will increase taxes and reduce allowances to cover the cost of the Covid-19 pandemic. Maximising this year’s ISA allowance through an Investment ISA could make a real difference to your long-term financial security.

Read on to discover why beating the 5 April deadline is so important, along with tips on ensuring your money is working as hard as it should be.

Use it, don’t lose it

ISAs have a ‘use it or lose it’ allowance. This means that if you do not use your full £20,000 annual ISA allowance by 5 April 2021, it is gone for good. Using this year’s ISA allowance may be especially important because of rumoured tax hikes and allowance cuts in the March budget.

The tax savings that ISAs offer should not be underestimated. You can shield your money from income tax, capital gains tax (CGT) and dividend tax, which is especially advantageous if you are a higher or additional rate taxpayer.

By opening or topping up an existing ISA, more of your money will go towards achieving your goals.

Take advantage of tax-free returns

If you invest through an Investment ISA, the tax exemptions are especially powerful. This is because you don’t pay tax on investment growth or income.

Investments held outside of an ISA could land you with a hefty CGT bill. CGT is charged on the profits you make when selling certain types of investments. Each individual currently has a £12,300 annual CGT exemption, but this could be lowered to help pay the government’s Covid-19 bill.

It is sometimes possible to reduce CGT by offsetting losses against gains, but this can be complicated. It is far simpler to hold investments in an ISA where there is no risk of CGT when one is available to you.

It is also possible that the £2,000 dividend allowance will be cut in the budget. For dividends you receive above your allowance, basic rate taxpayers pay tax at 7.5%, higher rate taxpayers 32.5% and additional rate taxpayers 38.1% (2020/21 tax year). Again, potential tax changes could make it even more important to use your ISA allowance now.

It is also worth bearing in mind that income from many types of non-ISA investments is included when calculating your overall income tax bill. If your investments generate a very high level of income, this could push you into a higher income tax bracket.

In a nutshell, investing through an ISA offers a simple way of supercharging your investment returns.

Will cash deliver what you need?

During the pandemic, many people have spent less money and built up cash reserves.

Interest rates on cash ISAs and savings accounts are very low and often below inflation, so there is a risk your money will lose its real value over time. For example, Treasury-backed National Savings & Investments (NS&I) reduced rates on its income bonds to just 0.01% in November 2020.

The chart shows the extent to which inflation can erode the value of £100 over 25 years. An inflation rate of 2.5% would reduce the real value of your cash to just £54.50.

The impact of inflation on ‘real’ value of cash

Over time, inflation can reduce the value of your cash savings

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Source: RBC Brewin Dolphin

Impact of four hypothetical rates of inflation on £100 of cash over 25 years. For illustrative purposes only.

Although the UK CPI inflation rate measured just 0.6% at the last reading in December, it might increase again in the future and further erode your money’s purchasing power.

Shares beat cash over the long term

Investing through an Investment ISA will give your money the chance to grow above inflation and increase in value. The stock market goes up and down, but history demonstrates that, over the long term, shares beat inflation and perform more strongly than cash.

Analysis by RBC Brewin Dolphin shows that if you had invested £100 in the FTSE 100 between 1996 and 2021, it would have increased to £504.27 on a total return basis. This is even after adjustment for the effects of inflation.

Whilst you can’t rely on historical performance to predict future returns, it is worth noting that this period witnessed major stock market downturns, including the dot-com bubble, the start of the Iraq War, the global financial crisis and the Covid-19 pandemic.

Act now before it’s too late

There are only a few weeks to go until the current tax year ends. If you haven’t already used your £20,000 ISA allowance, it is a case of act now before it is too late. With rumoured tax increases and allowance cuts on the horizon, maximising your ISA allowance is more important than ever. Remember, interest rates on cash ISAs are extremely low currently, which could make an Investment ISA more suitable for growing your money over the long term. By topping up your ISA, you can boost your chances of reaching your goals.

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The value of investments, and any income from them, can fall and you may get back less than you invested.
Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.
Neither simulated nor actual past performance are reliable indicators of future performance.
Performance is quoted before charges which will reduce illustrated performance. Information is provided only as an example and is not a recommendation to pursue a particular strategy.
Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Opinions expressed in this publication are not necessarily the views held throughout RBC Brewin Dolphin Ltd.