Are you one of the many who rush to invest in an ISA before the April 5th deadline? Or are you more of an early bird investor, taking advantage of the start of a new tax year? The latter approach could help you maximise any returns you make, particularly with the £20,000 ISA allowance for the 2023/24 tax year.
Taking time out of our busy lives to think about our annual ISA allowance can be difficult. It’s understandable that many people wait until towards the end of the tax year to invest, sometimes leaving it right up until just minutes before midnight on the 5th (luckily our teams worked another late shift this year and were on hand to help).
However, if you have the money available, our analysis shows that over time you may be better off investing your full ISA allowance – or as much as you can afford to – as early in the tax year as possible. However, note that as with all investing, returns are not guaranteed and you may get back less than you invest.
The earlier in the tax year you start putting money away, the earlier you can start to benefit from compounding, and the tax-efficient investment returns can potentially mount up year-on-year. Of course, as with all investing, it is best to take a long-term view of at least three years. Make sure you keep some immediately accessible savings aside for your ‘rainy day’ pot, or for emergencies.
Invest early and reap the rewards
Since the ISA was first introduced in April 1999, UK savers and investors have been able to help their money go a little further with an annual allowance that doesn’t require you to pay income, dividend or capital gains tax on growth or returns.
When the ISA was originally introduced in 1999, the allowance was much lower than it is today. The maximum ISA allowance was £7,000, but the most you could save in a cash ISA was £3,000.
Our calculations show that if you’d contributed £6,000 to a medium-risk stocks and shares ISA on the first day of each tax year since 6th April 1999, you could have accrued £8,387 more than if you’d waited until 5th April the following year. That’s an additional return of over 6%, a sizeable difference that could have seen early birds achieve their goals faster than latecomers. However, remember past performance is no guide to future returns.
Source: Calculations based on each contribution invested 60% in UK equities and 40% in UK government bonds. Returns are market index returns less fees of 1.05% per annum. Market indices used are FTSE All Share total return index and BofAML Gilts total return index, data source: Macrobond AB. Monthly calculations are based on an investment on the first day of the new tax year and at the start of the next month thereafter. Data from 5/4/1999 to 29/03/2023.
Getting into a good investing habit
Of course, most of us don’t have £20,000 (the current annual ISA allowance) sitting around in a bank account waiting to be invested in an ISA – especially given the higher cost of living we’re all experiencing at the moment. But the good news is that you can still benefit from compounding returns by investing small amounts regularly – an extra contribution of £50 or £100 per month, for example, could make a big difference to your pot.
Our calculations again show that contributing monthly has historically generated better returns over the long term than leaving it to the last minute and making a lump-sum contribution.
If you’d contributed £500 every month since 1999, you could have accrued £1,280 in additional returns, compared to making a lump sum payment at the end of the tax year.
Making monthly contributions helps you get into a good habit, so you can look beyond daily fluctuations towards your long-term goals.
This calculation assumes that you stay invested throughout that period. There is still a risk you could lose money if you were to invest for only a limited time during that same period.
Have you considered a Lifetime ISA?
If you’re eligible and putting money aside for your first home or your retirement, then a Lifetime ISA (LISA) might be right for you. UK residents aged between 18 and 39 can open one and deposit up to £4,000 per year until the day before their 50th birthday.
For every pound you contribute, the government will add 25% – in other words, a maximum bonus of £1,000 every tax year until you’re 50. However, if you withdraw the money before you’re 60, and it’s not for the purchase of a first home valued up to £450,000, or a terminal illness, you’ll pay a 25% government penalty. This means you may get back less than you put in.
If you invest in a stocks and shares LISA with Nutmeg, we’ll invest that extra 25% on your contributions as they come in. Investing the bonus right away means your overall pot has more time in the markets and has a better chance of benefiting from compounding over time.
How about investing for a child with a Junior ISA?
If there are children in your family, how about getting in early on a stocks and shares Junior ISA (JISA) which has a £9,000 annual allowance?
A JISA needs to be set up by a parent or guardian for children under the age of 18, but parents, guardians, friends, or family, such as grandparents, can contribute to the account. The money contributed to a Junior ISA is gifted to the child, meaning only the child can access the money – and only after they turn 18.
At Nutmeg, you can only open a Junior ISA for a child who is under 16, and it could make sense to be even more of an early bird and open the account as soon as the child is born. The full 18 years means they may benefit from compounding, and given the long-term timeframe, the parent may wish to invest at a higher risk level.
With no income, capital gains or dividend tax paid on growth or returns, the money you invest has the potential to increase in value, particularly over a long-term period of at least three years. Why not help set up your child’s future by adding the 6th April to the diary to start investing straight away in a new tax year?
Be an early bird
Remember, whichever type of ISA works for you, the sooner you start, the sooner you’ll be on the way to reaching your financial goals.
[*] Nutmeg calculations using data from Macrobond AB. Market indices used are FTSE All Share total return index and BofAML Gilts total return index. Calculations based on each contribution invested 60% in UK equities and 40% in UK government bonds. Returns are market index returns less fees of 1.05% per annum. Monthly calculations are based on an investment on the first day of the new tax year and at the start of the next month thereafter. Data from 05/04/1999 to 29/03/2023
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance. Tax treatment depends on your individual circumstances and may be subject to change in the future.