For long-term investors, though, ISAs have lost none of their shine. The wrappers are not only flexible – they can hold cash savings as well as investments in stocks and shares, and recently to peer-to-peer loans – but all income and capital gains, however great, are free from personal taxation.
In 2015-16, savvy investors saved a collective £2.6 billion in tax on capital gains, dividends and savings income by using ISAs.
The limit on how much can be saved in an ISA each year has more than doubled since 2009, and is currently capped at £20,000. Any unused allowance cannot be rolled over, giving rise to the annual ‘ISA season’ scramble to save ahead of the 5 April deadline.
With interest rates on cash ISAs languishing near historic lows, there is limited incentive for cash savers to rush in much before the tax year end. For those investing in stocks and shares, however, the case for squirrelling money into their tax-efficient wrapper early in the year remains as strong as ever. Although as always, please remember that the value of investments, and the income from them, will fluctuate. This will cause the fund price to fall as well as rise and you may not get back the original amount you invested.
The power of compounding
The simple reason is compounding. The sooner money is invested the longer it can work to deliver returns.
Where long-term investors can afford to invest at the start of the tax year, rather than at the last minute, they not only gain a year’s performance but these extra gains will be reinvested in the market until they need the money. Over time, the effect of compounding can be significant.
If you invest in a fund that grows by 3% a year after charges, for instance, a £10,000 investment made on day one of the tax year will gain £300 after 12 months. Assuming 3% net returns over a 25-year investment period, this ‘extra’ £300 will compound to £628.
The more you invest, the greater the potential impact of early investing. Likewise the longer you are investing for, the larger the compounding effect.To emphasise this point, let’s take two investors: one invests £10,000 in their stocks and shares ISA at the start of each tax year for 10 years, while the other invests just before the deadline every year. Assuming annual returns after charges of 3%, the early-bird’s pot will be worth £3,439 more than the last minute man’s at the end of the decade. After 20 years on these assumptions, the gain would be £8,061.
Investing early in the tax year to benefit from compounding is most pertinent therefore not only for those saving for retirement, but also for parents investing for their children’s future through dedicated Junior ISAs, or JISAs.
These products, which can only be tapped when a child reaches the age of 18, carry the same tax-exempt status but only £4,260 can be saved into them each year.
Investing the maximum possible into an ISA each April will of course not be possible for most of us. The potential upsides of compounding can, however, be enjoyed by investing in a stocks and shares ISA as early as possible in the tax year, or through a plan of regular monthly investment.
When you're deciding how to invest, it's important to remember that ISA and Junior ISA tax rules may change in the future and their tax advantages depend on your individual circumstances. The value of investments, and the income from them, will fluctuate. This will cause the fund price to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.