Is an ISA really worth it?

Financial gurus bang the drum about making use of your ISA allowance.

Most of us know they shelter your savings and investments from UK income tax and capital gains tax (CGT). But, with generous tax allowances on offer, depending on your situation, you might not see the benefit today.

Take Cash ISAs as an example. Interest rates are at record lows. That means most people now need a sizable pot to start worrying about income tax on their savings.

UK basic rate taxpayers would need at least over £160k in a high interest easy access account, before paying income tax. For most people, that’s quite a lot.

But we still think an ISA should be the foundation of most savings and investment portfolios. You just need to look a bit further to see why.

This isn’t personal advice and we’re not tax advisers. If you’re not sure something is right for you, or you need help with financial planning decisions, please speak to a financial adviser. For help with complex taxation, please speak to an accountant.

Tax rules can change and any benefits depend on your circumstances.

At some stage taxes will rise

The government’s response to Covid-19 has been a huge increase in public spending – the aim to protect jobs and the economy. This has taken UK debt to a record £2.07tn. And climbing.

Whichever way you look at it, you can’t borrow money forever. At some stage the government will need to raise taxes to make up for all the borrowing and balance the books a bit more.

HMRC’s expected to collect £193.2bn in income tax for the last tax year (2019/2020). This tax year (2020/2021), the figure could be even higher. Other than increasing income tax rates, potential easy ways to raise tax could be changes to CGT, inheritance tax and even getting rid of the dividend allowance.

Saving and investing’s a marathon, not a sprint. It’s impossible to predict what will happen in the future. But tax rules can change more regularly than you might think, and their impact or benefit will depend on your circumstances. So, it’s best to think ahead, prepare and shelter yourself from any uncertainty.

We think it seems unlikely ISA tax rules will change – other than the amount you can add in each tax year. If all your savings and investments are in ISAs, you probably won’t have to worry as much if there’s a potential cut to the dividend allowance or if the government increases CGT.

Tax can be taxing

If recent events have taught us anything, it’s that the value of investments can change quickly. And while you don’t want to make rash decisions, you also don’t want tax rules to impact your decision making.

An ISA lets you make changes to your holdings without needing to think about the UK tax implications. That means you can focus more on growing your investments over the long term, rather than worrying about any tax bills that could come your way.

You don’t need to include investments in your ISA on your tax return. This saves you time, hassle and potentially difficult calculations to get it right.

And if you’re employed and taxed on a PAYE basis, an ISA could save you from needing to complete a tax return altogether.

It’s a small price to pay

The benefits of an ISA don’t need to cost a lot. Although you are limited by how much you can put in an ISA by the ISA allowance (£20,000 in the 20/21 tax year). This is the total amount you can put into an ISA this tax year. You can have a Cash ISA, a Stocks and Shares ISA or both.

Cash savings rates can vary between ISA and non-ISA products, so it’s always best to check the rate you’ll receive and weigh up the pros and cons in line with your other circumstances.

With HL, it doesn’t cost you any more to hold funds in a Stocks and Shares ISA. So you’re not paying any extra for the tax benefits compared to a Fund and Share Account.

For shares, ETFs, bonds and investment trusts in our ISAs we charge 0.45%, capped at £45 a year. For a Fund and Share Account we don’t charge.

HL Stocks and Shares ISA charges

HL Fund and Share Account charges

Which ISA is right?

If you think you’ll need the money in the next five years, it’s often sensible to hold cash.

Cash ISAs can be a more secure way to save over the short term. Unlike with investing, the value won’t go down. But over time they’re unlikely to keep up with or beat inflation – the cost of goods and services rising over time. This can erode the real spending power of your money.

On the other hand, investing in the stock market will likely better your chances of beating inflation over the long run. From 1899-2018 the UK stock market has outperformed cash in 76% of five-year periods. The odds climb the longer you invest. If you'd invested for 10 years, stock markets beat cash 91% of the time.

So if you’re putting away money for the long term, and are happy with the extra risks involved, investing could give you a better chance of growing your money.

Remember, past performance isn’t a guide to future returns. Unlike the security of cash, the value of investments and any income they produce can go up and down, so you could get back less than you put in.

More about the HL Stocks & Shares ISA