How much could you save by wrapping investments in an ISA now?

Amid the final call for ISA savings, interactive investor shares calculations that could save you money and four tips for ISA investing.

• A higher-rate taxpayer earning £2,000 dividend income per year will go from paying no dividend tax to paying £338 from 6 April 2023, rising to £506 from April 2024.
• A basic-rate taxpayer would face a dividend tax bill of £88 from the new tax year and £131 from April 2024.

The clock is ticking for investors to make use of the £20,000 tax-free ISA allowance before they lose it at the start of the new tax year – or as much of it as they can reasonably manage.

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With the tax-free dividend tax and capital gains tax (CGT) allowances set to be cut from April, those with assets held outside their ISA wrapper face a higher tax bill to cash in on their investments.

Myron Jobson, Senior Personal Finance Analyst, interactive investor, says: “We’re facing the highest overall tax burden in a generation thanks to the deep freeze of tax thresholds and allowances which, in tandem with wage inflation, means we’ll be more in tax in the years to come. The upcoming cut in annual tax-free allowance for capital gains and dividend taxes will add insult to injury for investors with cash held outside ISAs and pensions tax wrappers.

“The changes impact those who have maximised their tax-free ISA and pension allowances, but also less affluent investors who have not had the time or the know-how to explore tax-efficient options.

The dividend tax annual allowance is set to be reduced from £2,000 to £1,000 from April and again to £500 from April 2024. Meanwhile, the CGT tax annual exemption is more than halving, going from £12,300 to £6,000 in April 2023, and to £3,000 from April 2024.

New calculations by interactive investor show a higher-rate taxpayer earning £2,000 dividend income per year will be liable to pay dividend tax of £338 from 6 April 2023, rising to £506 from April 2024 when the dividend allowance is cut again. A basic-rate taxpayer would face a tax bill of £88 from the new tax year and £131 from April 2024. Those scenarios are based on a £50,000 portfolio yielding 4% (shares in the FTSE 100 pay an average of around 4% dividend income).

A higher-rate taxpayer earning £5,000 in dividend per year would owe £1,013 in tax at present, rising to £1,350 from April and then £1,519 from April 2024. For basic-rate taxpayers, the amount owed in tax will increase from £263 to £350 in April and £394 from April 2024. Those scenarios are based on a £125,000 portfolio yielding 4%.

When it comes to CGT, the fall in tax-free allowance means a higher-rate taxpayer making a gain of £10,000 will be required to pay tax to the tune of £800 CGT after April, or £1,400 if they sell their shares after April 2024. For a basic-rate taxpayer, the figures are £400 from April and £700 from April 2024.

A higher-rate taxpayer making a gain of £20,000 would owe £1,540 in tax at present, rising to £2,800 from April and then £3,400 from April 2024. For basic-rate taxpayers, the amount owed in tax will increase from £770 to £1,400 in April and £1,700 from April 2024.

Myron Jobson, Senior Personal Finance Analyst, interactive investor, continues: “The shrinking dividend and capital gains tax allowances could provide the impetus for investors to invest through a tax-efficient wrapper if they haven’t already done so. Many of our customers were quick off the mark to do so after changes to both taxes were announced.

“Shifting investments into an ISA protects future gains and dividends from the clutches of tax. Known as Bed & ISA, the process is a valuable tool as a part of a broader portfolio spring clean strategy. The transfer, however, will involve selling and buying back shares, which could trigger a CGT bill.

“While ii charge commissions on the repurchase of investments into an ISA, and stamp duty may be applicable, Bed & ISA is tried and tested route to wrapping existing investments to generate the long-term benefits of a tax-efficient ISA – which over the long term is likely to outweigh the charges that might apply.”

“Self-invested personal pensions (SIPPs) can also be a solution, as dividends are tax-free within the wrapper. But bear in mind withdrawals that exceed the 25% tax-free allowance will be taxed as income.”

Myron Jobson outlines four tips for using your ISA allowance

1. Make the most of this tax year’s allowance – leave it in cash of you can’t decide

“The tax-free ISA allowance works on an annual ‘use it or lose it’ basis, so it makes sense to make the most of this year’s allowances - if you can afford to do so amid the cost-of-living crisis.

“The stakes are higher this year due to cuts in the CGT and dividend tax allowances from the start of the new year, which could have an impact on your financial planning.

“If you’re worried about the markets, you can always secure this year's allowance with cash now and take your time choosing when to invest your cash. There is no charge to do so, and it can potentially be more diligent in selecting investment opportunities. You can also drip feed it into the market if you wish.”

2. Consider making use of partner’s ISA allowance

“You can also help reduce your taxable income, by transferring assets between spouses/civil partners. Use both sets of ISA allowances: each year you can shelter £20,000 from tax in an ISA – so £40,000 between two. Couples can also effectively double gains and income they can make tax free by using both their annual exempt amounts. Only married couple and civil partners can transfer assets tax free, meaning those who aren’t could potentially trigger a tax liability.”

3. Consider consolidating old stocks and shares ISAs

“If you have multiple numbers of stocks and shares ISA, bringing them all under one roof could have added benefits beyond the convenience factor. Moving might also save you money in the long run as some providers charge more in custodial and investment fees than others.

“You can consolidate your ISAs into one of your existing ISA accounts (if your provider accepts ISA transfers) or you can transfer into a new ISA. Remember, you can't put money into the same type of ISA in the same tax year. So, if you have two stocks and shares ISA, you'd need to wait until the next tax year to put money into the second stocks and shares ISA.”

4. Beware of being too cautious

“Ideally, even when the stock market appears rough, it is still worth investing if you can afford to keep your cash wrapped up in investments for at least five years (ideally). History has shown that investing can yield better results than cash savings over the long term. Nervous investors can drip feed investments monthly to help smooth out the inevitable bumps in the market, buying fewer shares when prices are high and more when prices are low – a process known as pound-cost averaging.

“As ever, diversification remains the name of the game when it comes to investing. Casting your investing net further afield across different regions and sectors allows you to spread the risk and reduce volatility to give the best possible chance of generating sustainable and growing income.”

Impact of cut in dividend tax and capital gain tax allowances across different investment scenarios

Source: interactive investor

Dates for your diary – fast-approaching ISA and Junior ISA deadlines

• New ISA applications – Deadline -  11.30pm, Wednesday 5th April*
• New JISA applications – Deadline - 11.30pm, Wednesday 5th April*
• Add money to your ISA/JISA by debit card – Deadline - 11.30pm, Wednesday 5th April**
• Add money to your ISA/JISA by internal transfer - Deadline - 11.30pm, Wednesday 5th April***           
• Add money to your ISA/JISA by bank transfer – Deadline - 11.59pm, Tuesday 4th April****        
• Bed & ISA/JISA instructions – Deadline 4.30pm, Friday 31st March*****