At a time when making tax-efficient investments is more important than ever – with inflation soaring, currently sitting at a four-decade high of 9% as of April 2022 – it’s crucial that experienced investors make the most of their ISA allowance and everything the tax-free wrapper has to offer.
In order to do so, there are four key points to consider when subscribing your ISA allowance, from spreading it across multiple ISA products, through to subscribing the allowance in full each tax year (where possible).
1. Consider splitting your ISA allowance across ISA products for diversification
There are four Adult ISA products available – the Cash ISA, Stocks and Shares ISA, Innovative Finance ISA (IFISA) and Lifetime ISA. Each tax year, you are able to subscribe your ISA allowance to one of each of these products.
This is because your allowance can be split. It does not need to be subscribed in full to just one ISA (though it can be if you wish). And there are benefits to spreading your allowance across ISAs, namely the ability to reap the individual benefits of each ISA product and build a diversified, balanced portfolio.
With interest rates hovering around historical lows – the best rate on the market for an instant-access Cash ISA at present is just 0.82% – the Cash ISA is unlikely to be the best ISA for growing your capital. In fact, because interest rates are failing to keep pace with inflation, funds currently in a Cash ISA are being eroded and their purchasing power diminished.
But having Financial Services Compensation Scheme (FSCS)-protected cash savings within your wider portfolio is still important, and because it is benefited by the ISA tax wrapper, this means the Cash ISA could still have some value.
What’s more, the ability to split your ISA allowance means experienced investors can subscribe funds to the low-risk but low-yielding Cash ISA for safe keeping, whilst also subscribing to the higher-risk, higher target returns IFISA and Stocks and Shares ISA.
As a result, you could incorporate the long-term growth potential of the equities market into your ISA portfolio, whilst balancing its well-known volatility with the IFISA, which typically offers more stable, fixed target returns often in excess of an inflation-beating 7%.
As an example of how an experienced investor could split their ISA allowance, investor one may choose to subscribe £5,000 of their 2022/23 allowance to a Cash ISA, £5,000 to a Stocks and Shares ISA, and £10,000 to an IFISA.
On the other hand, investor two may have ample cash savings from previous tax years, and wants to now focus on potential capital growth. Therefore they could evenly split their ISA allowance, subscribing £10,000 to an IFISA and £10,000 to a Stocks and Shares ISA.
2. Remember the rules surrounding subscribing your ISA allowance
The annual ISA allowance for 2022/23 is £20,000, and you must ensure you don’t subscribe more than this within the tax year (which runs from 6th April to 5th April the following year).
It is up to you to make sure you do not exceed the allowance. If you do, funds subscribed above the allowance will not benefit from the usual tax-free returns, and you must contact HMRC as soon as you realise your mistake. If you don’t realise you’ve oversubscribed, HMRC will contact you.
There are also rules to be aware of regarding how many ISAs you can subscribe your ISA allowance to each tax year. As mentioned, you can subscribe to one of each type of ISA per tax year.
Therefore, an investor could split their 2022/23 ISA allowance across a Cash ISA, Stocks and Shares ISA, IFISA and Lifetime ISA. However, they could not subscribe to, for example, two IFISAs within the same tax year.
3. Where possible, subscribe your full ISA allowance each year
Understandably, this may not be possible for everyone. But for those experienced investors who are able to, subscribing the ISA allowance in full each year is a crucial consideration in order to maximise potential returns.
The full value of the ISA tax wrapper is evident when understanding that in order to target a return of 7% – a figure often targeted by the IFISA – outside of the wrapper, it equates to a Gross Equivalent Return of over 12% for additional-rate taxpayers.
Spreading your full, tax-free ISA allowance across a range of ISA products each year results in unrivalled opportunities to build a hard working, diversified portfolio that can help you achieve both your saving and investment goals.
And remember: you can not carry any unused ISA allowance over into the new tax year. This means that from 6th April 2022, you will lose any 2021/22 allowance you have not subscribed, therefore it is time to consider subscribing your remaining allowance to use it to its full potential.
4. Utilise ISA transfers to ensure past ISA allowances are still working hard to meet your investment objectives
Arguably, the most valuable and powerful aspect of ISA transfers is that they allow you to ensure your past ISA allowances are continuing to work hard to meet your investment objectives, without having an impact on your current ISA allowance.
Any funds transferred from an ISA that were subscribed in a previous tax year do not deduct from your current allowance as long the official ISA transfer process is followed – funds should never be withdrawn from an ISA with the outlook to reinvest, as this removes them from the tax-free wrapper.
As a result, it’s possible and simple to alter the weighting of your ISA portfolio. As an example, investor one has £50,000 in a Cash ISA accumulated over past tax years, but they are disillusioned with the current rock-bottom returns their Cash ISA is generating.
As this experienced investor has a higher appetite for risk, they have decided to add both an IFISA and a Stocks and Shares ISA to their portfolio. Therefore, in 2022/23, they transfer £20,000 from their Cash ISA to an IFISA, as well as evenly splitting their £20,000 2022/23 ISA allowance between the IFISA and a Stocks and Shares ISA.
Investor two already has £20,000 in a Stocks and Shares ISA from the 2021/22 tax year. But they would like to rebalance their portfolio with a product that offers fixed target returns and is uncorrelated with the fluctuations of the equities market. To do so, they transfer £10,000 from their Stocks and Shares ISA to an IFISA, and also subscribe their full £20,000 2022/23 to the IFISA.
Making the most of the ISA allowance
23 years after its inception, the ISA continues to be one of the most generous tax incentives available to savers and investors in the UK.
And it’s clear that when using the ISA allowance to its maximum – and alongside useful features such as ISA transfers – there are ample opportunities for experienced investors to target attractive, tax-free returns.
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Originally published 14th March 2022, updated 20th June 2022.