Why ISAs are more important than ever

Since their launch in 1999, ISAs have been a good option to allow your wealth to grow away from the clutches of HMRC. However, the ISA wrapper has become even more important, as taxes rise and investment markets change. We see five key reasons why investors should pay particular attention to their ISA this year.

Please remember that the value of investments will fluctuate and returns may be less than the amount originally invested. Tax treatment depends on your individual circumstances and the ISA and tax rules can change. Chelsea does not offer advice and so you must manage your ISA yourself.

1. Capital gains tax has increased

Capital gains tax (CGT) allowances have been gradually eroded by successive governments in recent years. The annual CGT allowance has been reduced from £12,300 in 2022/23, to £6,000 in 2023/24 and only £3,000 today.

CGT rates also increased from 10% and 20% to 18% and 24% for basic and higher rate tax payers respectively. As a result, investments held outside of an ISA or pension wrapper, could very easily be subject to a future CGT liability. This has made the ISA wrapper even more valuable.

Fund pick: T. Rowe Price US Large Cap Growth has been a strong performer. It is up 125.8% over five years*, potentially leaving even small investors with a chunky capital gain.

2. Income tax rates are falling

A sneaky way for the Government to raise tax revenues without raising rates is to freeze the tax rate boundaries. This means that as wages rise, more people are drawn into higher tax rates. In turn, that will see more people paying 40% or even 45% on any income from their investments. The higher your tax rate, the more valuable the ability to generate a tax-free income through an ISA becomes.

If, for example, you are a higher rate tax payer and invest £10,000 in an equity income fund paying 4%, you would receive £400 if you held it in an ISA, but only £240 if you held it outside an ISA. This is important if you want to generate an income from your investments, but even more so if you want to reinvest those dividends. Just like compound interest, the gap between the two options will widen over time.

Fund pick: The CT UK Equity Income fund currently has a yield of 3.8%**. That’s £380 per year for a £10,000 investment in an ISA. Outside it, it dwindles to just £228 for those in the higher rate tax bracket.

3. Income is going to be big in 2024

Investors have had a bumper two years of returns from global stock markets. The MSCI World index rose 24.4% in 2023 and 19.2% in 2024***. It is perfectly possible that markets will have another great year: Trump is considered to be market-friendly, interest rates may drop further, and – outside the mega-caps – valuations do not look excessively high.
However, history suggests that it is more likely to be a year of consolidation, where a greater share of investors’ overall returns will come from income. Income may also provide a cushion for any volatility in share prices. If that income can be generated tax-free within an ISA, so much the better.

Fund pick: Guinness Global Equity Income – the fund gives a blend of income and growth. The historic yield is 2.1%****, with the managers focused on growth of dividends rather than absolute yield. 

4. There are some great income options

Just a few years ago, when interest rates were at rock bottom, investors had limited options to generate an income in their investments. Today, their options are abundant. Investors can achieve a high, inflation-adjusted income from a gilt, taking almost no risk at all if they hold it to maturity. High quality corporate bonds offer a similarly attractive income.

It’s not just bonds – the FTSE All Share currently has a yield of 3.6%. Even the FTSE Small Cap index generates an attractive yield of 4.2%^. Investors no longer have to choose between income and growth, but instead have a vast range of options that provide both. There is also property and infrastructure, former portfolio stalwarts that have hit tough times but now look ripe for reappraisal. The choices are vast: this year’s ISA investor should be like a kid in a sweet shop.

Fund pick: The Artemis Global High Yield Bond currently has a yield of over 7%^^. Its bottom-up conviction approach has helped it to find hidden gems in an inefficient market.

5. ISAs may not be around forever

The government is strapped for cash. The tax relief offered through Individual Savings Accounts (ISAs) is estimated to have cost the UK Treasury £6.7 billion in 2023/24^^^. While the Government will be aware that ISAs have been a popular option with investors, whether or not they are directing capital to productive areas of the UK economy is open to debate.

The Lifetime ISA is already subject to a review on its efficacy. Equally, some consolidation in the ISA industry continues to be discussed. If the government hits bad times, it is possible that it may bring all ISAs under review, or cut the allowances. Alternatively, it may limit them to UK-listed assets, or UK smaller companies. Either way, investors need to keep investing as much as they can for as long as they can, just in case those tax incentives don’t last forever.

Fund pick: GQG Partners Global Equity is a set-and-forget fund. It provides a concentrated portfolio of quality companies, with strong growth prospects, managed in a benchmark-agnostic way.

*Source: FE Analytics, total returns in pounds sterling, to 16 January 2025
**Source: FE Analytics, 17 January 2025
***Source: MSCI index factsheet, 31 December 2024
****Source: fund factsheet, 31 December 2024
^Source: FT Market Data, at 15 January 2025
^^Source: fund factsheet, 30 November 2024
^^^Source: Resolution Foundation, 6 April 2024

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.