I say this for only two reasons;
- The fact that the UK tax year runs from 6th April to the 5th April
- The power of compounding
There are 2 main vehicles in the UK to protect your income from tax. An ISA or a pension. You can of course use both.
I do not intend to get into a discussion of the relative merits of each scheme but will say that the ISA provides more flexibility the Pension a significant enhancement payment from HMRC on entry.
The ISA is limited to a maximum £20,000 contribution this tax year and £20,000 next. The pension is limited to your annual earnings or £40,000 pa.
To explain the issues I want to focus on let us say that you have £15,000 that you can invest and you are skilful/lucky enough to be able to compound this at 10% per annum for the next 20 years. You pay tax at the 20% rate. (ISA’a and Pensions both have provider fees which we will set at £100 pa). All assumptions are of course open to amendment.
After 20 years, the fund becomes worth;
£69,914 held outside a wrapper
£95,796 held inside an ISA wrapper
£115,367 held inside a pension wrapper
A pretty clear indication that putting what you can into an ISA or Pension is usually a good idea.
However there is a wrinkle that I think a lot of people miss. All the current activity about maximising your ISA or Pension provision is aimed at get the money in before the tax year ends. But for the savvy investor it also needs to be around getting the money in as soon as the tax year starts.
In my example returns compound and as anyone knows a compounded return maximises in the last year not the first.
In the first year of my worked example the returns were
No wrapper £1,200
ISA £1,300
Pension £4,700 (Reflects the pension contribution from HMRC)
For some people these differentials are not enough to generate action, particularly between and ISA and no wrapper. The loss of flexibility on pensions is enough to put a lot of people off.
But by delaying putting money into a wrapper you do not lose the first year of compounding you lose the last year. In my 20 year example you would only get 19 years if you delayed.
The 20th year compounds are;
£5,179 no wrapper
£8,618 ISA
£10,397 Pension
By delaying one year you lose the biggest gain of the period, no matter which method.
Now clearly this is not individual advice and everyone’s situation is specific to themselves. If you pay tax at 40% the variations between different options is even greater. But depending on your situation you ought to be acting to safeguard as much of your money as you sensibly can in a tax exempt wrapper and you should be aware that it is not a matter of doing what you can at the end of the tax year, but given the power of compounding you ought to be doing what you can as soon as the new tax year starts.
Just as an aside you do need to ensure that your tax wrapper does not have onerous charges. Excess charges would of course dramatically affect the outcome.