6 ISA Things To Do Before The New Financial Year

The Individual Savings Accounts (ISA) is an invaluable tool for people in the UK striving towards financial independence. There's nothing like earning an income from your passive investments and not needing to pay any tax on it whatsoever.


With the 2020/21 financial year drawing to an end on April 5th 2021 it's time to make sure we're financially ready by not accidentally leaving "money on the table" - typically in the form of unused allowances.


In this article I wanted to cover 6 things you should check and do before the new financial year of 2021/22 starts on April 6th - some of these things might be "obvious" but it's always good to be sure, and I feel that some of these things can easily be overlooked.


To save you the effort of scrolling down the entire article here's the 6 things I will cover:


  1. Maximise your allowance

  2. What to do if you're nervous about investing a lump sum in a Stocks & Shares ISA

  3. Deposit any withdrawals back into your Flexible ISA

  4. Transfer investments from your General Investment Account into your ISA

  5. Junior ISA: Plant the seed for your kids

  6. Double allowance for 16 or 17 year olds


If you've already done these things then you're probably in good shape. But if any of these things made you go "oh!" then read on to find out what you can do and why.



When you know you're ready for the new financial year, life can be enjoyed more fully.
When you know you're ready for the new financial year, life can be enjoyed more fully.


Maximise your allowance


Each year you can deposit a certain amount of money into your ISA - known as your annual allowance - and any gains via interest, dividends or growth within the ISA will remain tax free regardless how much it is.


In the current financial year (2020/21) the annual allowance is £20,000, and each financial year starting on April 6th you get a new annual allowance for your ISA (also £20,000 for 2021/22). This means that any allowance in the current tax year cannot be carried forward.


Quite literally, it's use it or lose it.


Now I know that £20,000 in a year is quite a lot of money but considering the tax advantages of having your money in an ISA in comparison to a normal taxable account, such as a savings account or general investment account, it's best that you use as much of your allowance each year as possible.


The type of ISA you use will be important because certain accounts will be more suitable depending on what you want to do with that money in the future.


Here's a list of the different ISA types available:


A list of the different types of Individual Savings Accounts.
You can deposit a total of £20,000 into an ISA in the current financial year, but certain ISA types may have lower limits. You can spread your money out between different ISAs depending on our savings goals.

Typically you should invest any money that you intend to save into the long term (5+ years) to capitalise on the tax-free gains, while anything that is intended to be for the short term should be kept as cash.


The table above gives a brief example on what each account is used for but you can get more detail in an article I wrote previously - Secrets of the ISA: Part 1.


Regardless of your motivations, the key point is that you should utilise whatever annual allowance you have left or risk missing out on it forever.


If anything, putting any money that you're not thinking of spending in the next couple of months into an ISA to utilise the allowance is probably a smart move since you could always simply withdraw it back out if you need to use it.



What to do if you're nervous about investing a lump sum in a Stocks & Shares ISA


If you're consuming a lot of material involving financial independence then you're going to be hearing a lot about investing your money into index funds. And if you're living in the UK you're going to be looking at using the Stocks & Shares ISA.


However, you might be facing a dilemma of "how much should you invest in one go?"


While there are studies that lump sum investments for large amounts are slightly better in the long run, it cannot be ignored that unit cost averaging - splitting your money to invest over a period of time instead of all at once - feels "safer".


After all, you don't want to get caught investing everything you have right before a crash. Even if you feel you're willing to hold on (as you should) you'd still feel like you might miss an opportunity to buy some investments at a cheaper price.


But the problem of unit cost averaging is that you need time to get all of your money invested. If you're splitting your money to invest over the next 12 months, you're going to miss the ISA deadline to use up your annual allowance for the current financial year.


So what should you do?


Increase the amount you're investing each month so that you use more of your ISA allowance?


Or bite the bullet and do a lump sum, and hope your timing isn't unfortunate?


Actually the answer is that you needn't do either.


What you could do is simply deposit all (or as much of) your money into a Cash ISA instead where it isn't exposed to the stock market, and then continue to buy regular amounts of the index fund by doing partial transfers from your Cash ISA into your Stocks & Shares ISA during the new financial year.


Since the money you're transferring is already within an ISA wrapper it won't utilise your future annual allowance provided you're correctly making the transfers.


This gives you the best of both worlds - you don't miss out on this year's annual allowance or use up next year's unnecessarily and you can continue to unit cost average your investments.



Deposit any withdrawals back into your Flexible ISA


Flexible ISAs allow you to withdraw money out of your account and re-deposit it back in without you needing to use up additional ISA allowance, since that money is still considered "within the ISA wrapper". However, the caveat is that any money you withdrew must be re-deposited within the same financial year.


Here's an example:


An example of how money can be withdrawn and redeposited into a flexible ISA without using additional annual allowance.
An example of how money can be withdrawn and redeposited into a flexible ISA without using additional annual allowance.

Here you can see that money was being deposited into the flexible ISA over a couple of years, utilising the annual allowance of £20,000. However in 2020/21 there was a £50,000 withdrawal from the ISA.


If the ISA is flexible this £50,000 can be re-deposited without using any additional annual allowance as long as it is still 2020/21.


If you miss the ISA deadline without re-depositing the money you withdrew you will lose the chance to do so without using more of your annual allowance.


For example, if you kept that £50,000 outside of the ISA and waited until the new financial year of 2021/22 you would not be allowed to deposit all of it back into your ISA. You would only be able to deposit £20,000 which is the annual allowance limit for that year.


In my article Secrets of the ISA: Part 1 I cover a number of scenarios involving withdrawals from a flexible ISA that can help you get familiar with what's permitted and what's not.


Long story short - if you withdrew any money from your ISA this financial year, check that the account is "flexible". If it is, then you still have a chance to get as much money back into your ISA without double-dipping on your annual allowance. Once you've missed your window you will need to use next year's annual allowance in order to get your money sheltered from tax.



Transfer investments from your General Investment Account into your ISA


If you've been investing any money outside of a Stocks & Shares ISA you might want to consider utilising your capital gains allowance to get some of those investments inside an ISA wrapper.


Most people in the UK have a capital gains allowance of £12,300 and a dividend allowance of £2,000 for the year of 2020/21.


By utilising your capital gains allowance to take profits on any investments in a general investment account you will be able to keep what you made tax-free up to the allowance limit and then put that money into a Stocks & Shares ISA where you could re-invest it.


The greatest advantage of doing this is that any further gains on those investments will be completely tax free, regardless of how much the profits you make are. This is ideal for any investments you make long term where the power of compounding returns has turned your initial investment into a small fortune.


The other advantage is that you can reduce the amount of dividends tax you pay.


Any investments you have in a general investment account could potentially pay you a dividend which would be taxable if above the dividend allowance amount of £2,000.


However, if you moved your investments into a Stocks & Shares ISA any future dividends received from those investments would become tax-free.


Not only that, those dividends wouldn't consume any of your dividend allowance meaning you'd be able to keep more of your dividend income from investments that you still had outside of an ISA.


Under most circumstances it isn't possible to directly transfer your investment holdings from a general investment account into a Stocks & Shares ISA. Instead you need to sell your investments to get the cash, deposit that money into your Stocks & Shares ISA and then use that money to rebuy any investments.


Keep in mind that this process will use up some of your ISA annual allowance (there's no avoiding this), so if you have more than £20,000 in investments outside of an ISA you might only want to sell a part of it to maximise your allowance usage, and keep the rest in a general investment account where it can continue to grow.


You can always repeat the process next year once you've got your new annual allowance.


The process is known as Bed and ISA and I explain the nuances in my article Secrets of the ISA: Part 2.


One more reason to get your investments into a Stocks & Shares ISA as soon as possible is due to the fact that the government will assess and adjust their financial policies based on the health of the economy and their forecasts. While this could bring future changes that are beneficial it could also mean rises in taxes.


If you're waiting until such announcements are made you might find yourself in a bit of a pinch with the limited amount of your investments you can shelter each year. Best to get it done as early as possible so that you know you've at least used the tools available to you to protect your own wealth.



Junior ISA: Plant the seed for your kids


I don't know about you but ever since I discovered the world of financial independence for myself I always wish that I "got started earlier". This is because "time" is the biggest contributor towards success when it comes to compounding returns from investments, and a 10 or 15 year head start would be nothing short of phenomenal.


Don't get me wrong, I'm incredibly fortunate to be in the situation I'm in right now but one can always dream.


While we should all be appreciative of our own circumstances there's no reason not to plant some seeds for those whom you love and cherish, your kids.


Children under the age of 18 are eligible to open a Junior ISA which allows them to save up to £9,000. This £9,000 becomes sheltered from tax just like it would in a normal adult's ISA and when the child reaches their 18th birthday the account automatically converts into an adult ISA where they can continue to make their own deposits (with the full adult's annual allowance).


Furthermore, the money in a Junior ISA can be invested into stocks & shares instead of sitting as cash. This is where the "getting started earlier" is possible - you might not be able to do it for yourself but you certainly can get things started for your own kids.


Assuming you maxed out the allowance each year from the moment your child was born until their 18th birthday, they would have an ISA valued at £162,000.


And that's purely if you kept it as cash.


Imagine if you were investing that money into an index fund over the years, returning on average 7% each year. A quick calculation puts the value at over £300,000!


If your kid never invested anything further and simply kept their investments until the age of 65, at an average return of 7% each year they would retire with about £7.4 million.


If you think that's crazy let me remind you that this money is within an ISA so it's going to be tax-free. Now that's crazy!


Now I know maxing out your kid's allowance is going to be really difficult - especially if you have more than one - but don't let that discourage you from trying to give them a big head start. You might not be able to do £9,000 each year (you have your own retirement to think about after all) but could you do £100 (one hundred) a month?


Investing £100 a month for your child into a Junior Stocks & Shares ISA would grow to about £42,000 by their 18th birthday (7% average annual return), and if they never invested a single penny more that investment would turn into over £1 million by the time they reach the age of 65.


Plant the seed for your kids and give them the head start that you wish you had for yourself.




Double allowance for 16 or 17 year olds


Children (young adults?) aged 16 or 17 sit in a very special group of people who can qualify for a Junior ISA and an Adult Cash ISA. This is because the minimum age you can open an Adult Cash ISA is 16 years old while your Junior ISA stays with you until you turn 18.


And you're able to put money into both.


Having two ISAs might not sound like a big deal, until you realise that the junior's £9,000 annual allowance is treated separately from the adult's £20,000 annual allowance.


This means someone at the age of 16 or 17 can put a total of £29,000 into an ISA within a single financial year.


This "loophole" seems to have been around for years (albeit with the previous years' respective annual allowances) and seems to be known by HMRC - and they don't seem to have any issue with it being taken advantage of.


My guess is that they haven't dealt with it since it's extremely difficult for a 16 or 17 year old to actually hit these limits because let's be honest, most people never will. But nevertheless, if you are in the lucky group of young people with plenty of money then you might as well use this loophole while you can.


One thing to keep in mind is that the Adult Cash ISA is the only type of adult ISA account where this is possible as the other types have a minimum age requirement of 18 years old.


Another reason to wish you were young again.



To Conclude


Whenever chatting with my friends about investing, financial freedom, financial independence or however you want to call it, the benefits of the ISA is often an important element to helping us reach the goal. After all, who doesn't want to pay less tax on their money?


I did previously do an analysis on if a Stocks & Shares ISA really mattered when it comes to tax, and if so by how much.


In that article I concluded that there were plenty of different allowances that a person could utilise which would actually keep their tax bill to a minimum, but ultimately the simple tax-free nature of the ISA beats any alternative.


Additionally those calculations were based on current allowances and the tax rates applied to different sources of income, so it's all subject to whether or not the UK government decides if the current taxes should be kept the same or changed in the future.


With that in mind the only thing we can do is to use what's available to us at the moment in order to protect our wealth from the tax man - so make sure you get it done before the current financial year is over.



Hey - just one final word before wrapping up - I wrote an article in the past about how a small debt with a high interest rate can easily wipe out your investment gains, even if the investment had a fairly large head start.


However, as with most things financial, it always comes down to the math. Dollars and Drams makes an interesting analysis and says "Don't pay off all of your debt". If you're a numbers junkie then it's certainly an interesting read!


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Thanks for reading!

Kujah

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