While many people do use stocks and shares ISAs to invest for their retirement, you can withdraw mo (Image: Getty)
A financial expert has given her top money-making tip which thousands of Brits have used to accrue massive pots of money. The cash individual savings account (ISA) is a well-know savings tool which is used by more than 14million Brits.
Its benefits include a generous £20,000 annual limit and not having to pay any tax – including income tax or capital gains – on the money they make within the ISA. Government research suggests that 66 per cent of all ISAs held in the UK are cash ISAs. But while they come with clear advantages, you may find that you can do more with your money.
Claer Barrett is a writer for the Financial Times. She described the stocks and shares ISA – which sees your money invested in assets – as something Brits ‘can’t afford not to know about’.
Investing your money offers higher potential returns over a longer period of time and is once again protected from all forms of tax when done through a stocks and shares ISA, although it is also riskier. Claer explains: “Here’s a tip British investors can’t afford not to know about: stocks and shares ISAs. A fancy name for a totally legal tax haven for your money.
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“Every UK adult is allowed to save or invest up to £20,000 per year into tax-free ISA accounts. Most people have heard of cash ISAs – you won’t pay any tax on savings interest – but building wealth over the long term using stocks and shares ISAs offers far more substantial tax savings.
“So, imagine you’d invested £20,000 into a global index fund in your stocks and shares ISA every year for the past five years. That’s a total cash outlay of £100,000, but today it could be worth over £150,000 according to calculations by the investment platform AJ Bell.
“And because you hold this investment within an ISA, your £50,000 gain has been shielded from tax. Sell down your investments and you do not have to pay capital gains tax on any profits you’ve made. If you invested in shares paying dividends, there’s no dividend tax to pay either. And even if you made substantial withdrawals in the future, they would not count as income, so you would not have to pay income tax – a key difference from money that’s invested within pensions.
“Obviously, stock markets go down as well as up, so you need to be prepared to lock your money up for five to 10 years and have cash savings you could access in an emergency.”
Stocks and shares ISAs can include:
- shares in companies
- unit trusts and investment funds
- corporate bonds
- government bonds
- long-term asset funds
Statistics from AJ Bell show that an estimated 10,000 people are now ISA millionaires. Interestingly, if you added the maximum permitted amount every year from when ISAs began in 1999, you would only have contributed £330,000 – well short of £1million.
However, the power of investing lies in something known as compounding. Barclays says: “Compounding is when you earn returns on both your original investment and on past returns. It’s a crucial ingredient in successful long-term investing and saving. Legend has it that Albert Einstein once described compounding as the ‘eighth wonder of the world’.”
For example, if you invest £10,000 and earn 2 per cent in a year, it is then worth £10,200. The second year at the same rate would ring in a further £204, leaving a total value of £10,404.
These may seem like small increases but, if done year after year, the numbers start to add up. Ten years of 2 per cent annual compound growth on an original investment of £10,000 brings the pot to £12,190. After 20 years, assuming the same growth, the balance would rise to £14,859, with £1400 coming from interest in that final year alone. These figures become even more impressive when you consider they are tax free if done through an ISA.
AJ Bell claims that one ISA millionaire is just 33 years old. Claer said: “Have a dream of winning the lottery? Well, the number of Brits who’ve made a million pounds from their tax-free investment accounts outnumber those who’ve become millionaires by winning the national lottery jackpot.
“It’s estimated that 10,000 people in the UK have become ISA millionaires as the value of investments in their stocks and shares ISAs has exceeded a million pounds. A life-changing sum, but it’s not just down to luck.
“Let’s roll back to 1999 when ISAs first began. Even if investors had started there and invested the maximum amount permitted per year, every year, that would only add up to £330,000. So, the bulk of that growth has come from investment gains compounded over time.
“And this is where ISAs come into their own because those investment gains are tax-free. Yes, if those 10,000 investors were to sell up tomorrow, they would not be a penny of capital gains tax to pay on their considerable profits. If they withdrew money, they wouldn’t have to pay income tax either – a key difference from investing in pensions.
“And while many people do use stocks and shares ISAs to invest for their retirement, you can withdraw money anytime you want. You don’t have to wait until you reach retirement age. Investment platforms say that most ISA millionaires are in their 60s and 70s, and they’ve hit the jackpot by gradually building up a diverse portfolio of investments through the decades, benefiting from tax-free compounding.
“But some have taken riskier bets on individual stocks. AJ Bell says its youngest ISA millionaire is just 33 years old.”