Here's five quick steps to make the most of your ISA pot across the tax year.
1. Work out what you’re saving for
It’s much easier to maximise your savings if you know what you’re saving for, and it means you’ll pick the right ISA for you. If you need the money in the next five years, then you’re probably best keeping it in a cash ISA. But if not you could invest in a Stocks and shares ISA in the hope of higher returns. Are you saving for a house deposit? If so you could use the Lifetime ISA and benefit from a 25% top-up to your money from the Government.
Lots of people leave their money in cash, because it seems easier and they haven’t planned out what they want to do with the money. Rates on cash ISAs have improved since the Bank of England started to raise interest rates with speed and scale in 2022, but they are still unlikely to pay an inflation-beating return. If you assume investments return 5% a year after charges, a £20,000 ISA pot would have grown to £32,577.89 after 10 years. In that same period the cash account with the same £20,000 initial investment earning 3% would have turned into just £26,878. After 20 years the difference between the two pots would be more than £17,000.
2. Ignore the noise
There’s always going to be a reason to put off investing. Whether that’s rising interest rates spooking markets, inflationary pressures, or new political policies sending markets into a spiral. But if you’re investing for the long-term you need to get good at drowning out this noise and focus on what you think markets will be doing in five years or 10 years, not the next 10 minutes.
It’s notoriously tricky to accurately time the markets and buy at exactly the right time – even the professionals struggle to do it consistently. And in the time you’re waiting for markets to rebound, or for conditions to be just right you could be missing out on returns.
3. Give yourself a 25% boost
If you want to save for your first home deposit or want to top-up your retirement fund then make sure you’re not missing out on free Government cash. With the Lifetime ISA you can get up to £1,000 a year in Government bonus, up until the age of 50. If you opened a Lifetime ISA at age 18, that is a maximum Government bonus of £32,000.
The Lifetime ISA can be opened by those aged 18 up to your 40th birthday, and you can save up to £4,000 each year – either in one or more lump sums or as a regular monthly saving. You can withdraw the money to buy your first property or once you’ve reached age 60, but be warned that if you take the money for any other reason you’ll pay a 25% exit penalty.
4. Shift those dividends into your ISA
The amount of dividend income you could receive tax-free has been slashed in recent years, meaning that you now pay tax on any investment income over £500 a year, for investments held outside an ISA. Any dividend income you get above this amount is taxed at 8.75% for a basic-rate taxpayer, 33.75% for a higher-rate taxpayer or 39.35% for additional-rate taxpayers.
If you’ve got some of your ISA allowance left to use, and you have investments outside your ISA it could be smart to move as much of your dividend-producing assets into it as possible to avoid getting walloped with a tax bill. Once it’s in the ISA you won’t be taxed a penny of income tax on this pot.
If an investment pot of £100,000 yields around 4%, it means that by using an ISA, the investor could avoid £306 a year in income tax if they are a basic-rate taxpayer, £1,181 a year if they are a higher-rate taxpayer and £1,377 a year if they are an additional rate payer, if this money was in an ISA rather than a normal investment account.
5. Make your income earn you more income
Any dividends from investments in your ISA can be withdrawn tax-free, but if you don’t need the income now you could use them to turbo-charge your returns. If you reinvest them you can buy more shares in the same investment, which can have a dramatic impact on the size of your ISA fund over the long term.
This is because when you buy more shares each time you receive a dividend, you then receive more dividends next time there is a pay-out, which can then be reinvested again and so on. Some investment platforms allow you to set this up to happen automatically.
Let’s assume someone invests the full ISA allowance of £20,000 and we take the FTSE All Share’s long-term averages of a compound annual growth rate of 5.5% and annual dividend yield of 3.5% a year. After subtracting 1% a year for platform administration and fund fees, the initial £20,000 will be worth £47,729 after 20 years. £21,834 would also have been banked in cash dividends, to give a total return of £69,563. However, an investor who reinvests the dividends rather than banking them would have £91,678 – more than £22,000 extra. The figures become even more attractive over longer periods:
| 5.5% compound annual capital return only | Dividends paid in cash (3.5% yield) | Investment value + cash dividends | 5.5% compound annual capital return PLUS 3.5% dividend yield reinvested | |
|---|---|---|---|---|
| Initial investment | £20,000 | - | - | £20,000 |
| After 10 years | £30,896 | £8,580 | £39,476 | £42,280 |
| After 20 years | £47,729 | £21,834 | £69,563 | £91,678 |
| After 30 years | £73,733 | £42,309 | £116,042 | £196,282 |
| After 40 years | £113,903 | £73,940 | £187,843 | £420,240 |
Source: AJ Bell. For illustrative purposes only. Investment returns are not guaranteed.
Find out more about our Stocks and shares ISA
Find out more about our Lifetime ISA
Important information: A Lifetime ISA is not for everyone. If you withdraw money before age 60, other than to purchase your first home, you will pay a government withdrawal charge of 25%. This may mean you get back less from your LISA than you paid in. Also, if you choose to save in a Lifetime ISA instead of enrolling in, or contributing to, your workplace pension scheme you will miss out on the benefit of your employer’s contributions to that scheme and your current and future entitlement to means tested benefits may be affected. These articles are for information purposes only and are not a personal recommendation or advice.
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An AJ Bell Stocks and shares ISA is an easy, efficient way to invest. It’s completely tax free, so more of what you make stays in your pocket.
Written by:
Laura Suter
Laura Suter is head of personal finance at AJ Bell. She is a multi-award winning former financial journalist, having specialised in investments. Laura joined AJ Bell from the Daily Telegraph, where she was investment editor. She has previously worked for adviser publications Money Marketing and Money Management, and has worked for an investment publication in New York. She has a degree in Journalism Studies from University of Sheffield.
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