Hey ho all,
Great thread full of good, meaty debate.
There’s nothing I like more than a debate over personal financial strategy, so I thought it’d be good to post some reflections on the ISA.
I and the rest of the Freetrade team think the ISA is an amazing invention. It’s unique to the UK to have such a simple, generous, tax-efficient investment account. Many countries don’t have a direct equivalent.
So what does an ISA do?
It protects your investment capital growth (the increase) from capital gains tax and your dividends from income tax. It also lets you off the admin burden of reporting your gains.
You can put up to £20k into an ISA(s) each year. If you don’t make use of all of a year’s allowance, what you didn’t use doesn’t roll over - it’s gone. But each tax year you get a shiny new £20k allowance to add to what’s already there.
Personally I think it’s legit to start using an ISA from the outset even with a relatively small portfolio, for a few reasons:
- Avoid the mental burden of having to switch later
- Avoid the hassle and potential downfalls of the transition later down the line (more on these below)
- Certainty of knowing whatever your portfolio does and whatever your general finances do, your investments are safely tax wrapped in the ISA. For instance, if you invest in a great performer and your portfolio goes up faster than you were planning or you inherit some money
You’re correct that if your only aim is to minimise cost as much as possible AND you’re up for carefully managing when you start using the ISA, you could follow a strategy of starting off your portfolio in a Basic Account and transitioning it when you get closer to hitting the various tax thresholds.
You would want to sell off before your growth goes past the capital gains allowance (£12k right now) to avoid paying tax. You’d also need to have less than £20k total portfolio size to move it over to an ISA in a single stroke.
That would let you off the fee for the ISA, until you’re sure you need it.
There are also a few potential downsides with this approach:
- If you sell positions in a Basic Account and then re-buy in an ISA, you will pay market spreads and potentially stamp duty twice
- Unexpected gains from good investments which exceed your CGT limit before you can switch them to the ISA
- If you want to put in more than £20k when you decide to switch to an ISA (e.g. you receive unexpected amounts of money from a promotion or inheritance etc), you won’t be able to. Remember: you can’t reclaim unused allowance from previous tax years.
- Unexpected capital gains (e.g. selling a rental property, art etc.) could increase your total yearly capital gain when you want to sell your investments
- Government tax policy can always change
Our view is that ISAs are a great thing and worth investing in early. But if you’re sure you can outmanoeuvre those scenarios and are up for the micromanagement, go for it! I applaud your attentiveness.
Personally, it wouldn’t be my strategy, because you just never know what’s going to happen with your finances and your investments. Certainty is a very powerful commodity in life, so the certainty of the ISA is a very valuable thing.
A final word on why we charge a flat fee for the ISA, rather than a percentage of the account. We think it’s much, much fairer because it reflects our actual cost of administration which incurs on a per account basis, not on the value of the account.
In other words, it costs about the same for us to administer a £10,000 ISA as a £1000 ISA.
When providers charge a percentage-of-account fee, they’re basically assuming that the low fee on small accounts is more than made up by much, much higher fees later on when the ISA value accumulates.
We don’t want to do that and penalise success - we want to incentivise long-term investing that builds towards real life goals. And in most cases, the ISA is a very effective tool for that.
As always, of course, this is not financial advice and everyone should do what best suits themselves and their circumstances.