A new tax year started on 5th April 2020. This means a new set of allowances and tax-free incentives. One of these incentives is an Individual Savings account – or ISA for short.
Specifically, each year, we get an ISA allowances. This allows us to invest up to £20,000 in this tax year (which will run until 6th April 2021), and all of the gains will be tax-free.
In this post we’re going to be looking at how you can maximise your tax-free wealth in this tax year, and the years going forward.
What Is An ISA?
An ISA is simply a ‘wrapper’. Any money inside of this ‘wrapper’ will be able to grow tax-free.
MoneySavingExpert has a lot of detail on ISAs if you want to know more.
If you choose not to invest inside of an ISA, and instead invested in what is called a General Investment Account – or GIA for short – then any capital gains you make will be taxed.
Now, the capital gains will only be taxed when you sell, but imagine over the course of your lifetime you make a nice, compounded return, then when you come to sell, if you don’t invest inside of an ISA, 10% – 20% will be sliced off the top and go straight to HMRC.
Make sure you invest in an ISA! This will result in more money in your pocket.
Different Types of ISA
There are a range of ISAs, four in total:
- Cash ISA
- Stocks and Shares ISA
- Lifetime ISA
- Innovative ISA
In the post I will be focusing on Lifetime ISAs – or LISA for short – but MSE has very detailed posts on each type of ISA.
More graphics like this on our Instagram.
Lifetime ISA
This is the ‘wrapper’ I will be investing inside of for this tax year.
Why? Because the government gives you a 25% bonus!
We are only able to contribute £4,000 per year, out of the £20,000 allowance, but it makes sense if you are only able to contribute £4,000 or less to invest inside a LISA.
That £4,000 invested will become £5,000. A risk-free 25% return!
Of course, there are drawbacks. LISA providers often have higher fees, although this is greatly offset by the 25% government bonus.
Another drawback, the main drawback, is that the money can only be used for specific things – either buying your first house or for retirement.
But, our guess is that you will either buy a house or retire at some point, so depending on how you see it, this may not even be a drawback.
Stocks & Shares LISA
To go one-step further, inside of your LISA you can either ‘invest’ in cash or invest in stocks and shares.
Cash LISAs only offer around 1% – not great it seems. But add that on top of the government bonus and you’ve just made a 26% risk-free return!
No such thing as a free lunch. There is such a thing as a free 26% return on the first £4,000 invested!
However, I choose to invest in stocks and shares inside of my LISA. Specifically, in index funds.
I dollar-cost average into a global, diversified, index fund each month. Whatever I choose to invest, the government will give me a 25% bonus within 4-6 weeks.
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Stocks & Shares ISA
Not to try and confuse you, but there is also a stocks and shares ISA (as opposed to a stocks and shares LISA).
If you use up the £4k allowance in your LISA, then it makes sense to start contributing to your stocks and shares ISA.
A S&S ISA is something more people are familiar with, and the ‘standard’ choice. You don’t receive a government bonus, but all money inside of a S&S ISA also grows tax-free.
Utilise ISAs
Using this method I’ve written about in this post, you can contribute £4,000 into a LISA, and this will become £5,000 through the government bonus.
You can then contribute a further £16,000 to a S&S ISA, making the most of your tax-free allowance.
All of this money will grow, and compound, tax-free over the years.
Imagine investing for decades, contributing each month, compounding your returns, and never having to pay any capital gains tax… that’s the power of an ISA!
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Making Money Simple
Do you invest in a tax-free account?