Finding ways to mitigate tax is important when building wealth.
There are several taxes you might pay on returns or gains from investments, such as Dividend Tax or Capital Gains Tax (CGT). You might pay Income Tax on interest you generate from your cash savings too. If you’re not aware of this, it could be more difficult to achieve meaningful growth because you may lose a significant portion of your wealth to tax.
Fortunately, there is an excellent tax wrapper that could help you keep more of your wealth – the Individual Savings Account (ISA).
These accounts are incredibly tax-efficient as you don’t pay Dividend Tax, CGT, or Income Tax on interest or investment returns you generate from wealth in an ISA. There is no tax to pay when you withdraw the funds either.
As such, you might decide to hold your savings in a Cash ISA and purchase investments through a Stocks and Shares ISA. The beginning of the new tax year on 6 April 2025 could be the perfect time to take advantage of your ISAs.
Read on to learn why.
You might be more likely to use your full ISA allowance if you start early
ISAs are an excellent vehicle for tax-efficient saving and investing, and there is a generous allowance for annual contributions. In 2024/25, you can contribute up to £20,000 across all your ISAs. Crucially, this allowance resets at the start of a new tax year and you lose any unused allowance from the previous year.
That’s why you may want to use as much of your ISA allowance as possible each year. Doing so could be challenging if you leave it until the end of the tax year, as you might struggle to find a large lump sum to invest at short notice.
Conversely, if you start contributing to your ISAs as soon as your allowance resets on 6 April 2025, you can spread your payments throughout the year. This means you can incorporate them into your monthly budget and make more sustainable contributions to your savings and investments.
As a result, starting early could mean you use more of your allowance than you otherwise would if you’d waited until the end of the tax year.
Investing at the beginning of the tax year could increase your returns
If you’re investing in a Stocks and Shares ISA, you could increase your returns by making contributions at the start rather than the end of the tax year.
Figures from Vanguard show that if you invested £20,000 on 6 April 2024, and then an additional £20,000 at the start of each tax year, your pot could be worth £1,079,320 after 25 years (assuming 5.5% annual growth with charges deducted).
However, if you wait until the end of the tax year to start investing, you don’t give your wealth as much time to grow. Over time, this could significantly reduce the overall size of your portfolio. In fact, the data suggests that if you invested at the end of each tax year for the same period, you would have £1,023,052. This is roughly £56,000 less than if you invested at the beginning of every tax year.
In reality, you may be more likely to spread payments out across the year rather than investing the full £20,000 right away. Despite this, you could still benefit from investing as early as possible and giving your wealth more time to grow.
Additionally, it could be beneficial to start early if you’re saving in a Cash ISA too, because you generate interest over a longer period.
You could benefit from “pound-cost averaging” when you spread investments across the year
Making regular contributions to your ISAs throughout the year could help you balance risk when investing, as you might benefit from “pound-cost averaging”.
This is when you make a standard monthly contribution to your investments – let’s say, £500. Some months, unit prices might be higher and you won’t purchase as many units, while other months the price may fall, and you can buy more shares with your £500 investment.
As a result, the price per share usually averages out. Additionally, you may be able to reduce the effects of market movements on your portfolio by using this method.
In comparison, if you invest a single lump sum, you are at the mercy of the markets, to some extent. You may get lucky and invest when prices are low, meaning you see significant growth if markets bounce back in the future. Yet, you could also invest when prices are at a peak and see notable losses if the markets fall again.
So, by making regular contributions throughout the tax year, you could manage the level of risk you’re exposed to.
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Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.