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Many of us delay using our individual savings account (ISA) allowance until the end of the tax year, but there are several good reasons – particularly this year – for making the most of your allowance early on.
Each tax year, which runs from April 6 until April 5 the following year, you can pay in up to £20,000 into tax-efficient individual savings accounts (ISAs) and any returns you make will be free of both income tax and capital gains tax (CGT). You can put your allowance into a cash ISA, a stocks and shares ISA, or an innovative finance ISA, which invests in peer-to-peer lending or you can split your allowance between a combination of these options.
You’re not constrained to just one ISA of each type, either. If you want to open more than one of the same type of ISA this tax year, for example, perhaps you want a fixed rate cash ISA and a variable rate cash ISA, you’re free to have both.
Here, we look at five reasons why using your ISA allowance early in the tax year can reap rewards.
1. The cash ISA allowance is reducing
The cash ISA allowance is reducing from £20,000 to £12,000 from April 2027 for those aged under 65 to encourage investors to put their money into the stock market and British businesses rather than cash accounts. So you may therefore want to make the most of the current allowance while you still can. Our table shows some of the best cash ISAs currently available.
Top 5 Easy Access ISAs
Jason Hollands, managing director of Bestinvest, the online investment service owned by Evelyn Partners, said: “While it is undoubtedly true that too many people keep excess savings in cash and could be missing out on the higher long-term returns that can be achieved from investing, anything that reduces choice and flexibility is a step backwards.
“For some people, investing will simply be too risky and so a reduction in cash ISA limits will just end up exposing more of their savings to tax in standard savings accounts – particularly with the personal savings allowance frozen and dwindling in real terms. And don’t forget that additional rate taxpayers have no PSA at all, so their options to keep cash savings tax-efficiently could be closed off.”
Find out more in our article What could changes to cash ISAs mean for you?
2. You can take advantage of current high cash ISA rates
Economic uncertainty caused by conflict in the Middle East means that markets currently expect the base rate to rise rather than fall this year to help curb inflation.
As a result, ISA rates have risen in recent weeks, with some accounts paying savers in excess of 4.5%.One way to lock into current higher rates is to consider a fixed term cash ISA, where the rate is guaranteed to remain the same for a set period. Bear in mind, however, that you can’t usually access your savings during the fixed term, so this type of ISA will only be right for you if you can afford to leave your money untouched for a while.
Top 5 1-Year Fixed Rate ISAs
The good news is that there are currently plenty of competitive fixed term cash ISAs to choose from, paying inflation-beating returns. You can read about some of the market-leading deals available at the moment in our article Best cash ISA rates – which cash ISAs pay the most interest?
Top 5 5-Year Fixed Rate ISAs
3. Your money has more time to grow
Whilst past performances can never be relied on as a guide to what will happen in future, Hargreaves Lansdown has done some number-crunching to show the potential impact of using your ISA allowance at the beginning of the tax year rather than at the end.
It found that someone who invested their full ISA allowance in a stocks and shares ISA on the first day of the tax year every year for the past decade would have seen their investments grow to an impressive £357,168 (total return). However, if they left it to the last day of the tax year each year, they would have ended up with £322,855 – £34,313 less.
These calculations assume the full allowance was invested in the Legal & General International Index fund through a stocks and shares ISA.
Sarah Coles, head of personal finance, Hargreaves Lansdown, said: “The earlier you use your ISA allowance in the tax year, the better, because your investments have longer to grow, and are protected from tax straight away. Over the past ten years, investing on the first day of the tax year could have left you £34,313 better off than joining the last-minute ISA dash.”
4. Your money will be protected from tax earlier
The sooner your savings are inside an ISA, the sooner they’re shielded from income tax, dividend tax, or capital gains tax. Over time, these tax savings can really add up.
Ms Coles said: “If you have assets outside an ISA, then the earlier in the tax year you can move up to £20,000 worth of them inside the wrapper, the better. You can use the Bed & ISA process (share exchange) to make it straightforward.
“It means you’re protected from dividend tax before those investments have time to deliver a dividend. If you have a year of growth ahead, it also means those investments are building capital gains within a tax wrapper rather than outside it. Recent market falls could make it a sensible time to make the move, as you can shift more of your investments without busting the capital gains tax allowance.”
You can learn more about how Bed & ISA works in our article What is a Bed and ISA?
5. You’ll avoid having to make any last-minute panic decisions
If you delay using your ISA allowance until the end of the tax year, you might be tempted to rush in at the last minute and put your money into an account or fund which isn’t necessarily right for you.
Saving or investing early on in the tax year means you won’t feel under such pressure, and you can take a bit of time to make sure that you’ve chosen the right ISA home for your needs, based on your financial objectives, approach to risk and your investment timeframe.
Camilla Esmund, Senior Manager at interactive investor, said: “Even if you’re not ready to choose investments yet, adding cash to your ISA early puts your £20,000 allowance to work, and removes the pressure of a last-minute rush next spring.”
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