Skip to main content
  • Register
  • Help
  • Contact us
  • Log out of your HL account

ISAs: a tale of two investors

Tax isn’t always the biggest concern for investors, especially when they’re starting out. Investors are often more focused on picking the best investment or trying to time the market.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Tax isn’t always the biggest concern for investors, especially when they’re starting out. Investors are often more focused on picking the best investment or trying to time the market.

But with the UK tax take at a 30-year high – and strong evidence it could rise further – not investing tax-efficiently could cost you thousands over the long term.

That’s why we believe using your ISA allowance every year is so valuable. It often costs no more to invest in an ISA and your money is sheltered from rising taxes.

It makes your finances simpler and you’re free to make investment decisions, not tax decisions.

Below, we explain the tax benefits of ISAs and tell the tale of two hypothetical investors – one invested in an ISA and the other didn’t.

Discover more

The tax benefits of ISAs

ISAs are a gift from the government – and a generous one too.

We must all pay our fair share of tax – but to encourage us to save for the future, you can put up to £20,000 each tax year into ISAs, where your money has the potential to grow free of UK tax.

If your investments grow, you won’t have to pay capital gains tax. And if you’re investing for income, you won’t pay UK income tax either. The table below highlights the tax benefits of investing in an ISA.

All investments and their income fall as well as rise in value, so you could get back less than you put in

Non taxpayer Basic rate tax payer Higher rate tax payer Additional rate tax payer Investments held in an ISA
Tax on gains (in excess of £11,700 annual allowance 2018/19) 10% 10% 20% 20% 0%
Tax on dividend income (in excess of £2,000 annual allowance 2018/19) 0% 7.5% 32.5% 38.1% 0%

Tax rules can change and the benefits of investing in ISAs depend on your circumstances. Scottish tax payers pay tax on gains and dividends at the rest of UK rates.

Sensible Sally and Reckless Ron

Our research team looked at two hypothetical long-term investors. Let’s call them Sensible Sally and Reckless Ron.

Both investors invested the full ISA allowance into the FTSE All Share (the UK market) since ISAs were introduced in 1999. Their contributions totalled £206,560.

But Sally invested inside an ISA whereas Ron chose to invest his money outside a tax wrapper (such as an ISA).

As at the end of February 2019, their portfolios had grown to £261,173 and they are now higher rate tax payers. In the first scenario, they both take all their money out in one go and in the second scenario, they decide to start taking an income from their portfolio. So, how much tax did they have to pay?

Please bear in mind, the example below is based on a higher rate tax payer. A basic rate tax payer would pay less tax and an additional rate tax payer would pay more tax than the example.

Scenario 1

In the first scenario, both Ron and Sally have made a gain of £54,613 on their investments. But Ron paid £8,582.60 in capital gains tax (see table below) while Sally, on the other hand, paid no tax. What’s more, if Ron had chosen to reinvest the dividends he’d received, this amount of tax could have been considerably higher.

Value of portfolio (February 2019) Gain Rate of tax on gain Tax due on gain
Sensible Sally £261,173 £54,613 0% £0
Reckless Ron £261,173 £54,613 20% (on excess above £11,700 allowance) £8,582.60

Please note, this example is an illustration and past performance is not a guide to future returns.

Scenario 2

If both Sally and Ron decided to take an income from their portfolios, their tax burden would also have been different. Based on the current yield of 4.29% on the FTSE All Share the income generated on the £261,173 portfolio is £11,204.32. Income will vary though and this isn’t a reliable guide to future income.

Because Sally has invested in ISAs, she doesn’t have any UK income tax to pay on her investment income. But Ron is not so lucky. As a higher rate tax payer, he has to pay 32.5% tax on £9,204.32 (total income minus £2,000 dividend allowance).

This results in £2,991.40 extra income tax for Ron to pay via his tax return.

And that’s just the tax for one year. Depending on future taxes, he would continue to pay tax on the income he received.

Open or top up an ISA in minutes

As Sally and Ron’s example shows, it often makes sense to keep investments in ISAs over the long term.

This article is not advice. If you are unsure of the suitability of an investment for your circumstances, please seek advice.

And with the end of tax year fast approaching – 5 April – time is running out to open or top up an ISA this year. But don’t worry, it’s quick and easy to get started.

Once you’ve decided to open your ISA, you can usually open your ISA in minutes online. All you need is your debit card and national insurance number to hand.

Before you apply, please make sure you're happy with our terms and conditions (including Tariff of Charges) and key features.

Discover more

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Daily market update emails

  • FTSE 100 riser and faller updates
  • Breaking market news, plus the latest share research, tips and broker comments
Register

Related articles

Category: Investing and saving

My ready-made ISA portfolio was so easy to set up

Mrs Kylie Bawden explains why she decided to invest in a ready-made ISA portfolio. Read more.

31 May 2018 3 min read

Category: Investing and saving

ISA millionaire - ‘I like the challenge of trying to grow my money’

A HL Client shares his top ISA tips

Henry Irving

11 Mar 2019 5 min read

Category: Investing and saving

Cash: the easiest Stocks & Shares ISA decision

Henry Irving highlights a stress-free way to secure your ISA allowance this tax year.

Henry Irving

22 Mar 2016 min read

Category: Investing and saving

Don’t know where or when to invest this year’s ISA?

Henry Irving offers a simple solution if you don’t know where to invest this year’s ISA. Read article

Henry Irving

26 Mar 2018 2 min read