Quick context before the detail: decided not to bother with a stocks and shares isa? you might be missing these 3 things! sits at the intersection of a few real-world decisions most readers face at some point. Here is a clear summary of what is going on, and why it matters.
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Earlier this month, the annual contribution deadline for an ISA came and went. Some investors took advantage of the opportunity to put more money into their ISA, but many did not.
As one door closed, though, another opened.
We are now in a new tax year, replete with a fresh ISA contribution allowance.
Millions of people may end up not fully utilising their allowance this year. But I think not using an ISA can lead people to miss out on some potentially valuable benefits.
Here are three of them.
1. The discipline of a deadline
Have you ever scrambled to try and meet a deadline, whether for a test, a work meeting or a payment?
Deadlines can be annoying. But they often succeed in achieving the goal of getting people to do something they would otherwise happily keep kicking down the road.
Lots of people think they want to start investing, but put it off year after year – and sometimes decade after decade.
Using the annual ISA allowance as a motivation to start buying shares during the current tax year can be a helpful nudge to stop procrastinating.
2. Keeping dividends shielded from tax
One of the things I like about a Stocks and Shares ISA is that if shares inside it pay dividends, I can keep them inside the tax-free wrapper.
That means that I do not have to pay income tax on those dividends, as I may have to do if they were held outside a tax-free wrapper, for example in a share-dealing account.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Why does this matter?
It means that the process of compounding could be even more powerful, as the dividends can be used exclusively to buy more shares, not for paying tax.
For example, one share I think investors should consider right now is FTSE 100 financial services provider Standard Life (LSE: SDLF). It offers a dividend yield of 7.4%.
This means that if someone makes a £10k investment in Standard Life in their ISA today, it will hopefully earn around £740 per year in dividends. Free of tax, those dividends could be used to buy more shares.
The £10k compounded at 7.4% for a decade ought to more than double in value, to over £20k.
3. Capital gains that aren’t taxed
Untaxed dividends are not the only potential tax advantage of a Stocks and Shares ISA.
Capital gains that accrue inside the ISA are not taxed when the money is ultimately withdrawn from the tax wrapper. So an ISA can offer an effective way to grow capital value, away from the clutches of HMRC.
That can be a big deal. Over the past year alone, for example, the Standard Life (formerly known as Phoenix Group) share price has grown 31%.
With its chunky dividend yield, an aim to grow the payout per share annually, and strong recent performance, Standard Life’s appeal can seem obvious.
Longer term though, the share price has performed weakly, losing 1% over the past five years.
Partly that reflects a risk I still see: choppy financial markets could force the company to write down the value of some assets, hurting earnings.
But with its massive UK customer base (one in five UK adults are clients) and strong brands, I think Standard Life could continue to be a strong cash generator.
