ISAs provide the opportunity to receive tax-free income and gains.
Using an ISA to invest £10,000 each year for ten years will provide a pot of £100,000 plus accumulated interest and dividends which also generate tax-free returns.
Over a number of years this can be a viable alternative to a pension fund as proceeds can be taken at any time and there is no requirement to wait for retirement age and no limit on the amount that can be withdrawn. However, unlike contributions to a registered pension scheme, there is no tax relief on ISA subscriptions. On the plus side, there is no tax to pay when the funds are withdrawn from the ISA, whereas withdrawals from a pension in excess of the tax-free lump sum are taxed at the individual’s marginal rate of tax. Also, there is no need to wait until age 55 to make a withdrawal.
ISAs are also useful for the retention of income within the fund, as this is received tax-free. This means that the fund can grow at a faster rate than if the funds were held outside an ISA where potentially up to 45% of the investment return would be taxed.
Craig has invested in a stocks and shares ISA over a number of years. On reaching the age of 50, Craig decides to give up work and cash in 50% of the balance in his ISA. In doing so, he realises a capital gain of £50,000.
The gain is free of capital gains tax. If he had made the investments outside the ISA he would have been liable for capital gains tax on the gain. Assuming that Craig is a higher rate taxpayer who has used his capital gains tax exemption elsewhere, investing within an ISA has saved him capital gains tax of £14,000 (£50,000 @28%).
ISAs also provide flexibility as to withdrawals, which can be made at any age. There is no need to wait until age 55 as with a registered pension scheme.