Failing To Use Their ISA Allowance Could Cost Value Investors Over £1m

16th Mar '23 by Mark Simpson

5 comments 1162 reads

Some investors may have never bothered to use their ISA allowance. The current Capital Gains Tax allowance of £12,300 may have seemed generous enough to cover any gains, while a tax-free dividend amount of £2,000 may have covered most of the portfolio income. But, unfortunately, this relatively generous allowance is coming to an end, as the following table shows:

tRmBK0fr-Xz00Sf-kLX4YJjEjDdYKj7e_1oahw4G1PZXElo-EHvWa34fDaTT4ddG40_FbKSTF9bdN-eZtPaihMNlywmhKefBBaCr84lhwca47WvMX7VyEaL20KmhH4W37oKCcOmAV2iXdyyPkmPFzpA

There is also the risk that these allowances never get raised in line with inflation, further reducing allowances via stealth taxation.

An investor that has filled their ISA every year for five years and generated some reasonable returns could easily have £150k in their ISA by now. But what happens to the ISA investor over the next 25 years versus an investor who had the same amount in a General Investment Account (GIA)?

Modelling the impact

To model this, I need to make a couple of assumptions: the investment returns, what proportion of those returns come from dividends, and how often an investor may turn over their portfolio. To start with, I assume the long-term market averages, which is approximately 9% nominal return, half of which comes in the form of dividends. For the Turnover Ratio, academics Barber and Odean found that the typical individual investor turns over 75% of their portfolio yearly. Of course, an investor turning over 75% of their portfolio annually may have much higher fees than an index tracker. However, since I am interested in the comparative performance here, I will ignore the impact of fees on performance since these will be similar for an ISA or a GIA.

LTF_Ylz_zAxhwS8vONyjmpvCUp05dnKOQ4IlPEpsRqdeR18OL631S1g3fgbMmhHx4cJuZJL5cDABigJMw0nRu40fXYsUNJQBDpCn64Rgvp0gNI5PPHt8jncljTFIXeeS0llfTJwvekIZ7zzggwWabGY

Starting with the £150k on 1st January 2023, I assume that over the next year, the portfolio generates £6,750 of capital gains, of which 75% or £5,063 is realised, and £6,750 of dividends. Since this gain occurs in Tax Year 2023/24, there is no capital gains tax to pay. But £5,750 of the dividends are taxable. The net amount after taxes, I assume, is reinvested back into stocks, giving a portfolio value of for the basic Rate Taxpayer of £162,997 and £161,599 for the Higher Rate Taxpayer. This is compared to the ISA investor, who has kept all the gains and has a £163,500 portfolio after reinvesting their dividends. (Again, I am ignoring costs since this…

Unlock with Email

Unlock with Google

Already have an account?
Login here

Silver Moon

16th Mar '23

This makes for grim reading Mark but well done. My take is that the government wants people to spend all they earn, as it is earned, the shortest cut to communism as you can get. Of course, there need be no change in the pecking order, no need for opposition parties in politics either since they are all in it together. Glad that I am well into my fourth quarter and here's luck to the rest when the ISA is laid to rest.

dunns_river_falls

It will be nice to get back to making some decent capital gains! I have plenty of losses to offset against future gains. Although I am still trying to get as much into the ISA as possible before year end.

Any ideas what happens if I sell a share not in an ISA at a loss, buy it back in the ISA and later sell it for a profit? Can I still use that loss to offset against other non ISA gains? I am a bit of an ISA rookie, but realising I need to make maximum use going forwards.

raggedtp

Any capital gain or loss is crystallised only at the point of sale. So you make a loss. The value is entered into your ISA. From that point, ANY gains or losses are disregarded, and you don't even report your ISA. BUT, ISA losses cannot be used to offset gains elsewhere. Just think of your holdings as going into a black box. Remember also that dividends are tax-free and not reported.

AND, they haven't changed the Flexible ISA. If you set it up as that, you can extract as much as you like, and you can put it back in during the year, useful if, like me, you take income from ISA divs now but find you have some spare at the end of the year. I will put a bit back in in the next two weeks, to refill. After April 5th your annual allowance is gone. Nothing can be backdated.

Hope this helps.

Rusty2

Yes you can offset gains by losses, outside your ISA, it is the total gain, ie profits minus losses = gain for CGT. So if you have made £15,000 profit from sales, you can then sell loss making shares to reduce your gains to below your CGT allowance. You can deduct costs, such as buying and selling fees also.

ISA you don't need to declare anything.

I would look to get the highest dividend shares within your ISA.

Thanks for your replies. Really useful. The dividend allowance changing was the key driver for starting to make better use of the ISA.

Failing to use their ISA allowance could cost value investors over £1m

Modelling the impact

Unlock the rest of this article with a 14 day trial

About the Author

Mark Simpson

5 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...