3 Reasons To Get An ISA Now

Published in Investing on 21 July 2011

It makes sense to avoid the end-of-year rush.

What happens around the end of March every year? Well, there's one unmissable spectacle in the investment world -- the last-minute flood of people rushing to open an ISA before they lose their annual allowance.

But that's exactly the wrong time of year to be doing it, and there are some very good reasons why.

A wasted year

As with all savings and investments, it's the compounding of returns that really makes all the difference (whether tax free or not), and if you leave one year's ISA investment until the end of the year, you'll not only lose that one year's interest (or dividend, or whatever form your return comes in), you'll also lose the compounding of that one year for the entire duration of your ISA.

Suppose you invest your entire 2011/12 limit of £10,680 on the last day of the ISA year, and then close out your ISA in 20 years time, again on the last day of the year. If you average a 6% return per year over the period, that initial £10,680 will end up worth around £34,300 (the exact figure depends on when returns are paid, etc).

But if you invest on the first day of the ISA year, and then leave the money there until the same end date, you'll effectively get 21 years of tax-free compounding out if it, and the final value of that initial £10,680 will be about £36,300 -- a full £2,000 more.

And that's with a modest 6% return. If your investing is more successful and you achieve 10% per year, the difference will be between £72,000 and £79,000 -- a staggering £7,000!

Of course, the stock market doesn't rise in a smooth straight line, so we've simplified things here a little. But if you're investing each and every year, the ups and downs should even themselves out, and you'll get the benefit of an additional year across all the investments you've made.

Saving regularly

Another benefit that comes from opening your ISA early is that you will almost certainly be more motivated to stash money away in it at regular intervals throughout the year than if you leave it until the last minute -- and most ISAs, including shares ISAs, allow you to save very modest monthly sums.

Suppose, for example, at the end of a month you've got a couple of hundred quid left over and you wonder what to do with it. If you've already got an ISA open, that's the obvious place to put it, and once you've made the transfer you probably won't think about that bit of money again.

But if you just think "Oh, I'll just leave it in the bank, and if it's still there when I eventually get round to opening my ISA, I'll put it in then". But that means it'll be lying round for months, sitting there as a temptation the next time you see some fancy new high tech doodah or glittery bauble that you want but really don't need.

Which of the two approaches is more likely to see the cash saved, and which spent? I think it's pretty obvious.

More time to choose

The Foolish approach to ISAs is really to use them to cover investments in shares. If you're getting to save the tax on your returns, you might as well make the most of it, and over the long term the stock market has beaten cash hands down. So it makes more sense to protect your shares under your ISA umbrella than to cover cash with it -- especially in times when cash savings are offering pitifully low interest rates.

But you know what that means? It means you need to think about what shares to buy. And you're just not going to have the time to make a good choice if you leave your ISA until the last week of the year.

No, what you need to be doing if you want to get a decent shares ISA built up is looking for opportunities over the course of the whole year, and buying up the bargains as and when you come across them.

Get one soon

There are other advantages to starting your annual ISA as early as possible (for example, avoiding that sinking April 6th feeling when you wake up and think "Aarrgh, I forgot"), so it really does make sense to get it sorted out as soon as you can.

More from Alan Oscroft:

This summer -- don't just apply the sun cream,
apply for a Motley Fool Self-Select Stocks & Shares ISA too!

In the hot weather everyone knows to protect their skin against the sun, but what about protecting your investments from the taxman? That's just as important to your long-term financial health.

Motley Fool's Stocks & Shares ISA can help: Trade UK Shares for just £10 per deal Trade in shares on 7 of the world's largest markets Invest up to £10,680 this tax year* Open your account today and you could be trading online within minutes! Click here to learn more and apply online.

The value of your investments and the income from them can go down as well as up. You may not get back the full amount you have invested. If you're in any doubt about the suitability of an ISA, or whether to buy or sell shares, you should consult an appropriate Financial Adviser. *Tax treatment depends on individual circumstances and tax laws are subject to change.

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Comments

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kiffberet 21 Jul 2011 , 1:45pm

"And that's with a modest 6% return."

In this day and age, I consider 6% a decent return!

DIYIncome 21 Jul 2011 , 2:39pm

It's actually about the tax avoided, isn't it?. Some people don't even get ISAs, when in fact it would help them avoid tax. Believe it or not some people still don't understand how an ISA would help them. Not something you can remedy with an article like this, but mentioning tax benefits would help.

rober00 21 Jul 2011 , 5:04pm

Fine as long as you invest the money straight away. If not then you are better off in an high interest cash account. Isa interest is taxed at 20% , that is if you get any!!!

ANuvver 21 Jul 2011 , 6:33pm

Some confusion roberoo:

Do you know of any Self-Select Share ISAs that pay interest on cash balances? I thought it wasn't allowed.

TMFBoing 21 Jul 2011 , 7:10pm

In this day and age, I consider 6% a decent return!

To the long-term investor, "this day and age" is of no consequence - 2011's returns are of no interest to those with a 20-year horizon.

Best,
Alan

kiffberet 22 Jul 2011 , 1:55pm

I'd only use the term 'modest' when describing 3% returns based on gilts. For the last 10 years the ftse has been returning 3% yields and a nice loss of capital. Granted things might change in the next 10 years...but maybe they won't.

casablanca48 22 Jul 2011 , 4:10pm

Sorry to spoil the party but it should be pointed out that a standard rate tax payer is highly unlikely to benefit from investing in a stocks and shares ISA. There will be no tax savings on dividends and caital gains are unlikely to exceed the allowance of £10600 per annum.
Given that most stock brokers charge quite high mangement fees my advice to the small investor is to steer clear unless they can find a broker with zero management charges.

Fingered 22 Jul 2011 , 4:19pm

ISAs were introduced in April 1999 ...the FTSE100 then was at 6552 ( The close price for that month) ......so after more than 12 years, someone with a long term investing horizon has most likely LOST money with a stock ISA scam.....only 7 and a bit years to go. :-)

backdated 22 Jul 2011 , 4:24pm

At risk of repeating what Casablanca48 says above, this "ISA" thingy; can anyone tell me precisely (i e in real cash, pounds sterling, with perhaps even a decimal point) how much "tax" I'll save (and perhaps even net of any charges for the wrapper).

And how many folk are enveigled into taking risk they would not normally have been taking because of this alleged "tax shelter"?

Be wary of stupid politicians bearing gifts of questionable quality; most scandals seem to commence that way.........

casablanca48 22 Jul 2011 , 5:00pm

Hi back dated.
You ask about tax savings on a stocks and shares ISA.
If you are a standard rate tax payer there are no, repeat NO, income tax savings on your dividends. The tax on these has already been paid by the company and you will have nothing further to pay irrespective of whether or not your shares are held in an ISA.
With regard to capital gains tax yes all gains in an ISA are tax free but given that gains outside an ISA will be free up to the level of £10600 this is unlikely to be significant.
The marketing of ISAs as a tax saving product is highly misleading and really just a ploy by stockbrokers to levy excessive management charges on small investors.
Just for the record T D Waterhouse do not levy any management charges.

ANuvver 22 Jul 2011 , 5:27pm

I second casablanca and my ISA is with TDW.

If you're a standard-rate taxpayer an ISA is good for:

Parking fixed-income investments. The returns from these are classed as income and bundled together with your salary for the purposes of income tax. But if you put them in an ISA, they're invisible.

Sheltering offshore investments - ie those that pay dividends gross. You save the 10%. There are a few out there that are eligible and worth the trouble.

One massive punt. And it has to be a biggie.

TMFBoing 22 Jul 2011 , 5:36pm

There will be no tax savings on dividends and caital gains are unlikely to exceed the allowance of £10600 per annum.

Perhaps not on one year's investment. But what about when you have 20 years of investments built up - you could easily start seeing big capital gains then, and they'd all still be tax free in ISAs.

Also, a lot of people use up their annual CGT allowance anyway and still pay CGT on the excess, so an ISA would give them extra allowance even in just one year.

Best,
Alan

TMFBoing 22 Jul 2011 , 5:49pm

can anyone tell me precisely (i e in real cash, pounds sterling, with perhaps even a decimal point) how much "tax" I'll save

If you invest monthly for 20 years and use your full ISA allowance every year, and you achieve a share price growth of 5% pa, you'll end up with £ 362,637, of which you had put in £213,600. So that's a gain of £149,037 at the end of it. And you won't pay any CGT on it. (That's all at today's prices, but as allowances will go up with inflation, it makes reasonable sense to talk of today's values).

That's the big difference between annual CGT allowances and ISA allowances - CGT allowances can't be carried over, while your ISA gains stay tax free however big they get in the long run.

Best,
Alan

4spiel 22 Jul 2011 , 6:10pm

Often overlooked that you do not have to worry about the HMRC in an ISA. If you are in a trading account you can always be asked and if you actually do a high number of transactions then you are required to fill in an extra tax return whether or not you have made a chargeable gain .Some people forget that if you do a large number of transactions and you make profit that is your main income you may be deemed to b a trader and taxed differently whereas in an ISA that is not possible. I use TDW but have been looking for a cheaper ISA for this years allowancebecause sometimes if you can trade at £5-£6 you can make a profit on small trades but haven't decided yet.

4spiel 22 Jul 2011 , 6:40pm

Yes - no interest on idle cash in ISA is annoying . It would be good to find an ISA provider who does ! Also it would be good if you could go back and forth from a cash ISA. HMRC say they could not give the higher allowance tax free on cash. So I have written and asked -fair enough but you ought to be able to switch the basic £5350 back and forth -sometimes people want to get out of shares if they are frightened -why should the gredy bankers pay no intrest when they have the use of your cash . !!! Write to ministers@hmtreasury.gov.uk and complain too !!!

casablanca48 22 Jul 2011 , 6:43pm

Just for the record Alan I was referring to standard rate taxpayers who are most unlikely to save anything like the full ISA allowance every year.
ISAs are a great tax shelter for higher rate taxpayers and high net worth individuals but they have little to offer small savers.
It is misleading for brokers to market them as a tax efficient method of saving when in fact basic rate taxpayers will be paying management fees for no tax savings at all.
Small savers should seek a non fee charging broker which sadly does not include The Motley Fool
BTW I agree with ANuvver re fixed interest bonds

Fingered 22 Jul 2011 , 8:35pm

I have made a note in my agenda to : Panic first thing Monday morning, avoid the April 6th sinking feeling, and, dash to the local ISA shop. I'm feeling quite sick already.

backdated 22 Jul 2011 , 10:33pm

Thanks Alan.

"If you invest monthly for 20 years and use your full ISA allowance every year, and you achieve a share price growth of 5% pa, you'll end up with £ 362,637, of which you had put in £213,600. So that's a gain of £149,037 at the end of it. And you won't pay any CGT on it. (That's all at today's prices, but as allowances will go up with inflation, it makes reasonable sense to talk of today's values).

That's the big difference between annual CGT allowances and ISA allowances - CGT allowances can't be carried over, while your ISA gains stay tax free however big they get in the long run."

Agreed, but you don't talk of sales. An unrealised gain of £149,037 is as tax-free outside of an "ISA" as it is within - and unsold during your lifetime is CGT-free.

Conversely you cannot use losses that are trapped in an Isa, Therefore best not to "ISA" speculative investments? Perhaps "ISA" guaranteed fixed rate bonds instead?

All the best.

Backdated.

prommt 23 Jul 2011 , 12:28am

I thought the idea of ISA was to stop people spendng their money and saving for a 'rainy day'
All the rest has come from spivs trying to get your money by way of 'services'
Why does'nt the Motley fool get us fools to invest in the Motley Union Bank and get dividends at Credit Card rates , oh plus PPI.
As if!!

jackdaww 23 Jul 2011 , 3:29pm

i exceeded my cgt allowance on a single share - weir - and sadly it wasnt in my isa.

not having to put all this stuff onto a tax return is a big bonus.

ANuvver 23 Jul 2011 , 6:55pm

jackdaww:

So why not just sell part of your holding? What remains can then lose 18% of its value (at standard rate) until the tax-efficiency angle is negated. Not ideal, I know, but still. And congratulations for catching a whopper.

I agree that simplifying paperwork is a big plus point for ISA investments.

Forgot to mention above that returns from property REITs are also classed as income and can make good candidates for wrapping.

I still reckon that the CGT exemption is the most valuable aspect of ISAs, at least for us "minnows of the universe".

And don't forget that the chancellor giveth and taketh away. The current position on ISAs seems to be that they will remain in place for the foreseeable future. Index-linked CGT didn't last long, nor did MIRAS, nor tax relief on pensions. Nor tax-free dividends in "sheltered accommodation". As for Brown's assurances to Lloyds about exemption from monopoly concerns...

jackdaww 24 Jul 2011 , 12:58pm

anuvva

yes quite right.

i'd decided to lock in some profits on part of the holding and just forgot the cgt angle.

avoiding tax return work is a plus.

as someone has said, long term gains could be much greater than the annual allowance.

to make the most of the allowance do we need to sell and buy back every year - assuming we do that well.

Sharemaiden 24 Jul 2011 , 5:58pm

You can also use the ISA as a means to 'bed and breakfast' a share. For example if you have made a large gain on a share which you wish to crystalise, you can sell it then buy it back within the ISA. Normally you have to wait for a month if you wish to do this outside an ISA wrapper. Thus you do not miss out on any big rise in share price whilst waiting to repurchase.

ANuvver 24 Jul 2011 , 9:14pm

Good point - but bear in mind that the sale of the holding outside the ISA still counts as a chargeable event.

Incidentally, the "bed and breakfasting" effect (outside an ISA, ie with the enforced wait to repurchase) is a factor to bear in mind when watching share prices in March. Along with "window dressing".

It's an interesting time of year, what with some money being sent off for a steamy seaside break and some being flung around to tart up the shopfront...

psatek 26 Jul 2011 , 4:17pm

Also something worth bearing in mind is that you may not be higher rate tax payer now but you might be in the future at which point you may have saved more than the annual limit, so would then start paying extra tax on your dividends.

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