Cuts to tax allowances mean it’s more important than ever to think about topping up your individual savings account (ISA) before the end of the tax year.

The tax-free allowances for those who want to invest outside an ISA were cut this tax year and will be reduced again from 6 April. It therefore makes even more sense to shelter your investments from tax through an ISA.

Here, we explore four reasons to maximise your £20,000 ISA allowance by the end of the tax year on 5 April.

1. Tax-free allowances are becoming less generous

The main advantage of investing through an ISA is that it lets your money grow free from the income tax you might pay on the dividends1 or interest you receive, as well as the capital gains tax (CGT) that could be applied on any profits (‘gains’) you make when selling assets. 

If you invest via a general account there is no such protection, which means you could face a tax bill on dividends, interest and profits.

Prior to 6 April 2023, you could make tax-free profits of up to £12,300 each tax year, but this allowance was reduced to £6,000 for the 2023-24 tax year and is set to be halved to £3,000 for 2024-25. Profits over and above this level will be taxed at 10% or 20%2, depending on your other income.

Meanwhile, the amount of tax-free dividends you can earn each year was cut from £2,000 to £1,000 for the 2023-24 tax year and will be reduced again to £500 for 2024-25. How much tax you pay on dividends that exceed this allowance depends on your income tax band3.

By investing through an ISA, you don’t need to worry about these allowance cuts because all the profits and dividends you receive in an ISA are sheltered from these taxes.

2. The ISA allowance is a ‘use it or lose it’ allowance

A key reason to top up your ISA before the end of the tax year is that the ISA allowance is a ‘use it or lose it’ allowance. In other words, you can’t carry forward any unused portion of your allowance to the next tax year.

With the CGT and dividend allowances about to become less generous, the more of your investments that you can shield in an ISA, the better. If you delay, you could risk storing up a tax problem further down the road.

3. ISAs can help to supercharge your returns

Investing in an ISA instead of a general account could make a big difference to your overall returns. To help illustrate this, we calculated the potential returns for a higher-rate taxpayer who invests £20,000 every year over a 10-year period, starting from February 2024. They invest in a portfolio of shares from different sectors and regions of the world, earning an annual rate of return of 5% after costs.

The chart below shows the difference it would make if the money was invested in an ISA compared with a general account and then those investments were sold at the end of the 10-year period.

By investing through an ISA, the individual earns £12,678 more, simply by choosing a more tax-efficient account.

How investing tax-efficiently can boost returns

Source: Vanguard calculations. Notes: Based on a £20,000 annual investment. The 5% return used in the example is hypothetical and is not guaranteed (it is based on a 100% shares allocation with 1% income yield and 4% capital appreciation). Assumes a higher-rate taxpayer with a personal savings allowance of £500, a dividend allowance of £500 and a capital gains tax allowance of £3,000. Dividends after tax are assumed to be reinvested and the investments are sold at the end of the final year.

4. Account flexibility – and less admin

Another advantage of ISAs is you do not have to disclose ISA holdings on your tax return – unlike with a general account – which means there’s less admin involved.

Of course, if you’re lucky enough to have more than £20,000 to invest in a given tax year, you won’t be able to put it all in an ISA at once. Instead, you could consider putting anything above £20,000 in a general account to begin with and then move the funds into an ISA over subsequent tax years. This process is called “bed and ISA” and it can be a useful way of managing tax liabilities.

Bear in mind that the £20,000 ISA allowance applies across all your ISAs – for example, stocks and shares ISAs and cash ISAs – so make sure you don’t accidentally breach the overall allowance.

Another option is to consider putting some of the money into junior ISAs for your children. The junior ISA allowance is currently £9,000. Money placed in a junior ISA can’t be accessed until the child turns 18, so it can be a good way of saving for their future. At age 18, the junior ISA converts to an adult ISA and your child can manage and use the money as they wish.

Whatever your circumstances, we have an account for you. And, when you combine our account options with our high-quality, low-cost funds and easy application process, you have some great ways to gain access to world markets.

Dividends are the payments some companies make to their shareholders out of their profits.

Surplus capital gains on residential property are also taxable, but at a different rate. In most cases, your family home is CGT-exempt. However, profits made on second homes or property investments can incur a CGT charge. See the HMRC website for more information.

See the HMRC website for dividend tax rates.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

The eligibility to invest in either ISA or Junior ISA depends on individual circumstances and all tax rules may change in future.

Any tax reliefs referred to are those available under current legislation, which may change, and their availability and value will depend on your individual circumstances. If you have questions relating to your specific tax situation, please contact your tax adviser.

Important information

Vanguard Asset Management Limited only gives information on products and services and does not give investment advice based on individual circumstances. If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described, please contact your financial adviser.

This article is designed for use by, and is directed only at persons resident in the UK.

The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information does not constitute legal, tax, or investment advice. You must not, therefore, rely on it when making any investment decisions.

Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.

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