The increase in the annual ISA allowance to £20,000 in 2017 from the current level of £15,240 is extremely good news for investors. That’s because it makes ISAs even more appealing for people who are seeking to build a comfortable retirement and finish working a little earlier than they had previously planned.
Certainly, pensions are an option, but ISAs offer greater flexibility and their tax advantages tend to work out as being broadly similar to pensions in the long run. For example, ISA contributions may be from income that has already been taxed (unlike pensions, which enjoy government tax rebates on contributions), but withdrawing funds is tax-free (unlike pensions). ISAs also offer a huge amount of flexibility before retirement, and funds can easily be withdrawn at any time with no penalty.
As a result, ISAs have become extremely popular in recent years – especially as the current Chancellor has rapidly increased the annual allowance since 2010. Prior to the Coalition government, the annual ISA allowance was just £7,200, but following the recent Budget this figure has now been increased to £20,000 from 2017 onwards. That’s a rapid gain in just a handful of years, with the rise planned for 2017 representing an increase of 31% (or £4,760) versus the current financial year’s allowance of £15,240.
Retirement impact
This increased allowance of £4,760 per annum could have a huge impact on an individual’s retirement prospects. Assuming a 9.1% annualised rate of return (the annualised total return of the FTSE 100 since it started in 1984), investing an additional £4,760 per annum for 40 years would equate to a retirement fund £1.65m higher than it otherwise would have been. Many people would argue that such a figure is more than enough to retire all on its own and as such, it may not be necessary to work for a full 40 years in order to retire with a comfortable income.
In fact, assuming an individual will require an income of £30,000 a year in order to enjoy a comfortable retirement, they would need to have a portfolio value of £750,000 at retirement (assuming an annual withdrawal of 4% of the fund’s value, provided for by dividends). Using the current ISA allowance of £15,240 and the annualised rate of return of 9.1%, it would take an individual around 20 years of investing to reach their retirement goal.
However, under the new ISA allowance that figure falls, since investing £20,000 (rather than £15,240) at an annualised rate of return of 9.1% generates a total fund value of £750,000 after just 17 years. In other words, an individual can afford to retire three years earlier than they otherwise would have been able to under the current ISA allowance. And with tax-free withdrawals permitted at any time from ISAs, this could lead to an individual leaving the workforce as soon as their portfolio hits that magic £750,000 level.
So while the introduction of the Lifetime ISA and various other policy changes may have grabbed the budget headlines, the rise in the ISA allowance to £20,000 a year could prove to be the most important change made by the Chancellor for long-term investors.