If I ask you whats the best reason for getting an ISA, I reckon its a sure fire bet that youd point to the tax savings. And yes, it really is the whole point (though there are other advantages shared with other types of investing accounts).
Any share price profits you accumulate in an ISA are free of capital gains tax, and theres no further income tax to pay on any dividends either. Now, you might point out that in the UK we have an annual capital gains allowance, and that stands at 12,000 in the 2019-2020 year.
Big savings
So that means you can sell shares up to a profit of 12,000 without paying tax. With the annual ISA allowance standing at 20,000, youd have to do unusually well for that to limit you in a year, so whats the point of an ISAs tax-free status? Well, one is that you have to actually sell shares to use your capital allowance and you cant buy them back again for at least 30 days.
But the biggest tax advantage is that theres no tax savings limit every penny in your ISA, for as long as you like, remains tax-free, and it could come to a tidy sum. If you can afford the full 20,000 ISA allowance every year for 20 years, youll have invested 400,000 in total. But if you earn 6% per year (which I think is a reasonable long-term objective), it will have grown to 760,000 and the 360,000 profit is all tax-free.
Top performance
If that profit example sounds good, thats because UK shares are about the best long-term investment you can find. A study by Barclays has found long-term total returns (share price appreciation plus dividends) of 4.9% ahead of inflation. So my 6% example above is actually quite modest.
Its also miles ahead of anything youre going to get from a Cash ISA. Right now, top variable rates come in at around 1.35%. You can get a bit more from a fixed-rate ISA, but it means tying up your cash for a fixed number of years and even then it wouldnt get you close to the expected long-term returns from a Stocks & Shares ISA.
Cash ISA interest is below inflation, so you actually lose money in real terms. What kind of investment is that?
Savings discipline
You could still enjoy the long-term returns from shares in a plain share-dealing account, but weve already seen what the tax savings could be worth from choosing an ISA instead. And I reckon an ISA provides a non-cash benefit too, in the more disciplined approach to investment it can inspire.
Pretty much any online investment account will let you transfer cash regularly, so its as easy to be as disciplined as with an ISA providing you have the willpower and motivation. But I find that having an annual limit and a deadline to use it encourages me to be more regular and consistent with my investing.
I know Ill never use up my full annual allowance, and it shouldnt matter whether I miss deadlines. But it does provide me with a psychological boost, and it really makes me focus on my investments in the last couple of months.
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