The deadline for ISA contributions for the 2017/18 tax year has passed, but if you missed the cut-off, there’s no reason to worry.
The ISA allowance is a recurring one, and it refreshes at 00:00 every year on April 6. So if you forgot to make the most of your £20,000 allowance last tax year, you have 355 days left to take advantage of the benefit for this year.
And while that may seem like plenty of time to get your affairs in order, it is always best to start putting money aside as soon as possible.
Time to start saving
ISAs are a wonderful savings tool for investors of all shapes and experiences. Any investments held inside an ISA wrapper are tax-free — for both income and capital gains. In fact, you don’t even need to declare your ISA on your tax return.
With this being the case, it makes a lot of sense to start using up your ISA allowance as soon as possible. Even if you don’t believe you will benefit from the ISA’s beneficial tax status, it makes sense to use one because you don’t know what the future holds and they are flexible. You can take money out from prior years at any time, unlike pensions.
For example, if you used an ISA to invest £3,000 in a high growth stock today, and the value of this asset had grown to £30,000 by 2020, you could sell with no tax. However, if you made this investment outside the ISA wrapper, you will have to tell the taxman about your £27,000 profit and pay capital gains tax on the total (the rate of which depends on your income tax bracket). This could be as much as £3,050 for a higher rate taxpayer.
Put simply, it makes sense to start saving as much as possible into an ISA as soon as possible to make the most of its tax-free properties. The benefits might not seem apparent today, but they should have a significant impact on your wealth over time.
The power of tax-free compounding
As a rough example, if you invest £250 a month in a stock that pays a 5% dividend yield, assuming no capital growth and a basic dividend tax rate of 7.5% per annum, you will save £586,090 including dividend income of £436,090 over a period of five decades according to my calculations.
However, the same investment without tax will grow to a total of £665,200 with total income earned of £515,200, £79,110 more than the taxed sum.
Using a shorter time frame example. If you earned a return of 5% over the 12-month period from April 6 2017, to April 5 2018, on a £20,000 investment you would have earned £1,000 just for investing early and not leaving it to the last minute.
The bottom line
So overall, if you missed out on last year’s ISA allowance, it makes a lot of financial sense to get a head start on this year’s quota. Not only should you be able to achieve higher after-tax returns, but saving earlier will help you plan out your finances throughout the year.