Transcript: Isa season — how to build tax-free wealth

This is an audio transcript of the Money Clinic podcast episode: ‘Isa season — how to build tax-free wealth’

Claer Barrett
Hi, it’s Claer here. With just days to go until the end of the tax year on April the 5th, we’re in peak Isa season as UK listeners try to squeeze the most out of their tax-free savings and investment accounts. Isas, or individual savings accounts to give them their full name, are legal tax havens allowing you to earn interest on your cash savings tax-free and for your investments to grow tax-free into the future. They’re one of the most valuable tools investors have. And today’s show is dedicated to making sure you know how to make the most of them. Whether you’re a beginner or a more experienced investor, have I got tips for you.

In a minute, you’re going to hear highlights from my Isa webinar with fellow FT columnist Moira O’Neill and the financial adviser, Timi Merriman-Johnson, better known online as Mr MoneyJar. Recorded as part of my step-by-step money course, Sort Your Financial Life Out, if your finances need a bit of a spring clean, there’s more details on how to sign up in today’s show notes.

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Hello and thank you for joining us today in the FT’s London studio to learn more about the wonders of tax-free investing. I’m Claer Barrett, the FT’s consumer editor and presenter of our Money Clinic podcast. If you’re signed up to my Sort Your Financial Life Out newsletter series, you’ll already know quite a bit about this. But today’s discussion is going to be focused on Isas, that’s short for individual savings accounts, and how we can use them to both save and invest for the future. Here to help us learn are two fantastic experts who FT readers and Money Clinic podcast listeners will know well. Firstly, Mr MoneyJar aka Timi Merriman-Johnson, the financial educator and content creator who is now a qualified financial adviser. Welcome, Timi.

Timi Merriman-Johnson
Thank you for having me.

Claer Barrett
Well, great to have you here, looking dapper in your new suit. And joining to me is Moira O’Neill, an award-winning journalist. Moira writes a weekly column in the FT Money section on Saturday. She did a cracking job taking the British Isa apart last week. And you can also find her on social media. She’s @moiraonmoney. Great to have you here today.

Moira O’Neill
Thanks, Claer.

Claer Barrett
Channelling the traitors.

Moira O’Neill
I’m trying my best.

Claer Barrett
Your task, isn’t it? So let’s start with the absolute basics. Timi, can you give us a recap on how Isas work?

Timi Merriman-Johnson
Absolutely, Claer. So, as you said, Isa stands for individual savings account. And there are four types of Isas. There are cash Isas which our listeners are probably most familiar with. Stocks and shares Isas, lifetime Isas and innovative finance Isas. There’s an annual tax-free limit of £20,000 that you can put across all of them, with the exception of the lifetime Isa, which has its own limit of £4,000. And what’s most important is that Isas serve as a tax-free wrapper. So once your money is in that Isa environment, you don’t pay any tax on the growth of that money or on the income as well.

Claer Barrett
Yeah, I can remember when I first heard this term: a tax wrapper. And I was sort of thinking about a sweet or a chocolate. I mean, Moira, it is like that because it’s wrapping around that tax-free protection for you. But tell us a bit more about these different types of Isas.

Moira O’Neill
I think it is quite a confusing topic. You can have these four types of adult Isas and you have your 20,000 limit, which Timi’s just mentioned. But you can actually choose different types of Isa within that limit. So you could take out, if you had the money, you could take out £10,000 and put it in cash. And you can have £10,000 in a stocks and shares Isa. One thing to be really careful about though is the lifetime Isa. If you qualify for that, there is a maximum limit on that. So you can have £4,000. But don’t forget that you can have other types of Isa alongside that as well.

Claer Barrett
Yeah. And another common problem people often get wrong about Isas is they think that £20,000 is the limit of what you can have in your account. Full stop. But that’s just the limit of what you can pay in overall in a single tax year. April to April.

Timi Merriman-Johnson
Yeah, absolutely. So you get the £20,000 limit which resets on the 6th of April at the start of every tax year. And you can use this year after year. You know, there’s a way that I talk about Isas to try and get people excited about them and it’s that we had our first Isa millionaire in the UK in 2003, and since then that number has grown to 4,000. And these are people who have maxed out their Isa allowances. Every year the money has grown. They’ve received income to the point where they have seven-figure portfolios. And that’s such a large amount of money that they can live off the interest that money provides. So they keep the tree and they live off the apples.

Claer Barrett
I like that.

Timi Merriman-Johnson
Yeah. You can max out your Isa year of the year with the aim to build up a large principal sum.

Claer Barrett
OK. Well we’re going to do a couple of examples now, theoretical things that could happen to you as an investor. Let’s say one year ago, Moira, I invested my entire £20,000 Isa allowance in Nvidia, the AI chipmaker. Now risky, I know, but it’s just an example. Now their share price has doubled pretty much in the past year. So the money in my Isa that I’ve invested £20,000 would now be worth £40,000. Have I now got a tax problem?

Moira O’Neill
No. That’s the brilliant thing about Isas is that if you had held the Nvidia shares outside an Isa, you would now have a capital gains tax problem if you wanted to cash in your shares because you would have made a profit, and the government then taxes the profit that you make. So the difference between the money you put in and how much it’s grown. If you hold it in an Isa and it grows and you take the money out, cash in, because you’ve chosen a good investment and you want to then use money, you don’t have to pay the capital gains tax bill.

Claer Barrett
And I mean, just to take that example further, if only I had invested my whole life. Really. I mean, it’s one share and it’s very risky and hindsight, obviously, is a wonderful thing. But let’s say I do have that £40,000. It’s all Nvidia. And I’m now sitting here thinking, bit risky being in a single stock. I’m going to sell half of that money and I’m going to reinvest it in, say, a global tracker fund. Can I do that? Or by selling my investment within the Isa, have I committed any tax . . .?

Moira O’Neill
Within the Isa you can do what you want without triggering tax issues. So yes, you can change your investments. You can buy and sell your sweeties within the wrapper and mix and match what you want. And it can all grow and just keep growing and you don’t have to worry about it.

Claer Barrett
OK. So another example for you now again to demonstrate kind of in real life how the tax benefits of Isas can translate for you, we’re going to talk about dividends. So dividends is an annual payment to shareholders. If you own a share in a company you get a little bit of money back as a reward for being investors. So one of the top dividend paying stocks out there is BAT, British American Tobacco. Now for various reasons, they’re having to pay their investors big dividends. There are lots of worries about what could happen with vaping and smoking dying out. But they have a dividend yield of around 10 per cent. So that means if I have my £20,000 Isa allowance, again a risky example in BAT shares, I would be getting a dividend payment, 10 per cent of £2,000. So what advantage would there be to me again of having that within the Isa?

Timi Merriman-Johnson
Yeah. So that £2,000 would be tax-free. And if you were to build that up and up and up, then you could, in theory, get to a point where your principal sum, the amount that you have in the investment, is able to produce a dividend amount that is large enough for you to live off. So if you grew your portfolio to 600,000, for example, and you were getting a dividend of 4 per cent, you could get 24k. That’s like two grand a month.

Claer Barrett
So I mean, that really gives people an insight into how people pay into Isas throughout their working lives and then hope to reap the benefits later on by taking that income all the way in the future. When I’m withdrawing income from my Isa, what happens then? Do I have to pay income tax? Do I have to declare that on my tax return?

Moira O’Neill
You don’t. That’s the wonderful thing about Isas is when you — lots of people who use Isas for retirement planning because you can use them alongside pensions — when you get to retirement age, you can draw the income from the Isa free of tax, and you don’t have to put it on your tax return. So it’s a little bit of an admin benefits as well.

Claer Barrett
Now of course, not everybody is using their stocks and shares Isa to save for retirement. They are more flexible, however, aren’t they?

Moira O’Neill
Flexibility is a really important point and it’s why a lot of people use Isas alongside pensions. With pensions, your money is locked away until retirement age. Obviously you get compensated for that because you get income tax relief on the contributions that you put in. With an Isa, you don’t get that initial boost in income tax relief, but you get these wonderful tax benefits and you don’t pay tax on the growth and income from them. And they can compound over the years. But you can use Isas flexibly. You can take the money when you really want it, for whatever reason that might be. So people can use them to save for university fees or education purposes. They can use them to save for a child’s wedding in the future, for a deposit on a property and even those very long-term goals, such as retirement saving or even the big bill at the end of life, which nobody wants to think about, long-term care.

Claer Barrett
Mmm. Yeah, I mean, there has even been ideas floated to start. And I said products specifically for saving for your long-term care.

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Now there’s one Isa product that we haven’t mentioned so far which is the one for children, the junior Isa. Do you want to briefly tell everyone a little bit about that?

Timi Merriman-Johnson
Absolutely. And this is a question I get from a lot of people that follow me online, like how can I save towards my children’s future. So we mentioned the four main types of adult Isas, but there are also junior variations of the cash Isa and of the stocks and shares Isa. They have a smaller annual limit of £9,000, but they function in much the same way. You can pay into them every tax year. That £9,000 resets every tax year. And then when the child turns 18, it turns into an adult Isa. So, as Moira said, appropriate for things like house deposits, university fees, driving lessons, and even if you save small sums for a baby — and like I’ve had friends, I’ve helped open to, you know, Isas and stuff — because the money has time to grow over that 18-year span. You can start with relatively small sums, but reach quite larger ones by the time they get to adult age.

Claer Barrett
Now Timi, the first step, of course, before you can pick investments is choosing the platform. What are the options now for investors if they want to open a stocks and shares Isa? Because goodness knows, there’s an awful lot of adults out there who should be opening one of these accounts but haven’t got one.

Timi Merriman-Johnson
Yeah. The key thing to note is that the stocks and shares Isa is the account. If you want to open a stocks and shares Isa, then you need a platform or provider which you then open that account within. And broadly speaking, I’ll put in three categories of platforms. There are robo-advisers. These are platforms that are perhaps best suited to beginners because, you know, you sign up, you maybe enter a few details about yourself, and then you choose from a plan or normally be something like cautious, balanced or risky. And then it’s just a case of putting in set monthly amounts. Then you have DIY platforms. These are more suited to people who know what they want to invest in. And then there are commission-free platforms as well. Commission-free platforms tend to place more of an emphasis on buying individual stocks, ETFs, active funds, CFDs and that sort of thing. And those really rose in popularity during the pandemic. The people that I know started to invest. So yeah, once you pick your platform, then you open your stocks and shares Isa within it, and then you place your investments within that stocks and shares Isa.

Claer Barrett
OK. Moira, what would you like to add to this?

Moira O’Neill
Well, I’d like to add it’s very important to keep your costs low when you choose the platform.

Timi Merriman-Johnson
Of course.

Moira O’Neill
Because even very small differences of, say, £50 to £100 this year could compound up over the years to quite a big difference by the time you reach retirement in 30 years’ time. We’re talking about thousands of pounds in fees could potentially go. So when you’re choosing your platform, it’s a robo-adviser, DIY, et cetera, you should always think about what you’re going to be paying. And there are quite a few good tools out there on the internet to help you choose. One is Compare and Invest.

Timi Merriman-Johnson
Great website.

Moira O’Neill
Yeah, great website. And it’s actually got a tool where you can put in what you might want to do. And it tells you it gives you a recommendation. Boring Money is really good as well. They did lots of research and they did qualitative research as well. People’s experiences of using the different advisers. So that’s all.

Claer Barrett
That’s all free to read on the Boring Money website. Very very good results. Hol

ly Mackay, we’ve had her on the podcast before. Great lady.

Moira O’Neill
So yeah, do your research but don’t obsess over it. I’m saying, because you can go down the black hole of getting so confused and doing so much that you never take action, you never open the Isa. I think just be . . . the best thing to do is to do a little bit of research and then get going, because the important thing is to start investing.

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Claer Barrett
Now I want to get on to the types of investments that you can hold within the stocks and shares Isa. This is the real meat of our discussion. We’ve been waiting for it. We’re not going to tell you what to invest in or how to invest. We’re going to give you ideas. Now, stocks and shares Isa does put some people off because they think I’ve got to pick individual shares and I don’t feel confident about doing that. But that’s not the case.

Moira O’Neill
Not at all. You could pick something called a multi-asset fund.

Claer Barrett
That’s a key term: multi-asset fund, a bit of everything.

Moira O’Neill
Which does everything. It does the stocks bit, you know, the equities that are traded on the stock exchange for you and usually it does it globally. So it picks them for around the world. And it also does the stocks bits, which is the bonds bit, which gives you a bit of a mix of different types of investments within there. And it might add in other things like property in gold as well. That multi-asset fund is the thing to look for. And even if you, I mean, if you go to a robo-adviser, that’s the kind of thing they’re going to put you in. And if you go to a DIY platform, they usually have research recommendations that point you towards some of these. So they point beginners on their platform towards multi-asset, and that can do the job for you. It can be as simple as just choosing one fund.

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Claer Barrett
Now if we wanted to get a bit more exposure, perhaps to stock markets, that’s where all the growth has been. Recently big tech stocks in the US has really been powering things. What other options could there be for investors who are setting up an Isa for the first time?

Timi Merriman-Johnson
Sure. So there are individual stocks, which is how I got started. Although stock picking takes a lot of time and a lot of research and is...

Claer Barrett
Also a cost of your time.

Timi Merriman-Johnson
Yeah. And arguably is like the riskiest way to hold them because of the price of that individual stock could go to zero. So something I’m a big fan of are index funds or tracker funds that track global stock markets. So if we start with index, an index is just a grouping of publicly traded companies. The main index in the UK is the Footsie, which you may hear about on the news. The main index in the US is the S&P 500. You can buy funds that contain all 100 companies in the Footsie for example, or 500 companies in the S&P. You can buy global funds which track all the stock market traded, or the publicly traded companies in the world in the proportions that they exist in the global stock market. And the benefit of this is you get exposure to the stock market. It’s diversified rather than just being in one company. And as the proportions of stocks from different countries shift. So to build that global fund.

Claer Barrett
And I mean it’s interesting to note that lots of UK investors will have a lot of exposure to their home market to the UK. But when you look at it globally I think it’s only about 4 per cent.

Moira O’Neill
The other thing to think about when you’re chasing a tracker is you’ll get average performance of the stock market, which most people think, oh, I don’t want average, but average is actually OK because the risk is that you can choose, you choose the stocks, or you could choose an actively managed fund that tries to beat the stock market and do better. But the risk is always that you might do worse. You might lose more money. So picking an average, picking an index tracker is actually a good thing.

Claer Barrett
If you can be consistently average, the effects of compounding over time, then it would also be a good thing. Now you mentioned active funds there. That was actually my next question. Passive funds. Active funds. These are two phrases that people will be hearing a lot. But what’s the diff?

Moira O’Neill
Yeah. There’s a lot of jargon, isn’t there? So passive is the index tracker fund that tracks. It’s a bit like robotically tracks the global stock markets or the individual stock market like the FTSE 100 or the S&P. And then the active fund is managed by a professional human person with lots of high exams and experience, hopefully. And they try to hold different things to the index with the aim of outperforming over the long term. So growing your money faster for you. And the risk is that the active human professional fund manager takes the wrong risk or makes the wrong call and underperforms.

Claer Barrett
And you’ll still have to pay them their fee.

Moira O’Neill
Yeah. Then they usually do charge more as well. Active funds charge quite a significantly bigger fee than tracker funds on the whole.

Claer Barrett
Now, I suppose as a new investor myself, back in the mists of time, the fees on active funds don’t look that high because it’s normally something like 1 per cent or 1.5 per cent of your investment. You kind of think 1 per cent, you know, tiddly. But Timi, tell us why this is not the case.

Timi Merriman-Johnson
It’s because in the same way that investment growth compounds upwards over time, the amount of money that’s been taken out of your investment every year compounds in the other direction as well. So the higher the fee, the more money that’s being taken out of the money that you’re investing, the less of it is available to grow. So that results in less money over time. So the lower you can keep fees, the more of your investment you have remaining.

Claer Barrett
And say, fine. If your active manager is outperforming the market or even growing in line with the market, be nice. Many of them don’t even do that. But if they’re underperforming the market and you’re paying that fee, then that’s where the damage can really be done.

Moira O’Neill
I also make a point about active and passive. You don’t . . . It’s not either-or. You can do a bit of both. So lots of investors use a core fund that’s a really low-cost index tracking passive fund. And then they pick a few active funds to hold us like satellites around that in the hope that a little bit of their money might perform better. But the bulk of it is going to get the average performance.

Claer Barrett
And that’s something that I think more intermediate investors perhaps are gravitating towards. The thing is, with investment, there’s no better way about learning about investing than starting to do it. I think that’s the very key message coming across from our panel today for anyone hovering on the “open an Isa” button.

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Now let’s talk a little bit about what you can’t hold within an Isa. There’s one investment class that’s been dominating the headlines which is crypto. The price of Bitcoin is record high. Is it possible to hold Bitcoin within one’s Isa?

Timi Merriman-Johnson
Not at the moment. We do have a Bitcoin ETF in the US. But it’s not here yet.

Claer Barrett
Now if I wanted to have exposure to something like gold within my stocks and shares Isa, would that be possible?

Moira O’Neill
Yes. But it wouldn’t be like big chunky gold bars that you have in a safe. It would be investing through something called an exchange traded product. And this is a type of fund that invests in gold. Somewhere there is a vault with all the gold stored in it if it’s a physical product. And that will track the gold price for you and deliver a return equivalent to the rises or falls in the gold price. So a lot of people hold those, and they can be a really good way of getting in and out of gold when you think it’s going to be worth holding.

Claer Barrett
And then more broadly, there are funds which invest in commodities.

Moira O’Neill
Definitely. Yeah. So these are usually on the active side because they invest in not only the physical metals, but also things like the miners that mined the metals as well. And they could be a great way to get exposure. But you could also buy an ETF that does that for you, that tracks the miners, for example. You can get a few of those as well. There’s loads of options to get exposure. And probably most people should be holding a little bit of precious metals in their portfolio.

Claer Barrett
Even if it’s just a smidgen. We haven’t mentioned the B-word yet. Bonds. Now bonds, they’ve had a bit of a bad press since the disastrous mini-Budget under Liz Truss, where we saw the value of UK government bonds suddenly take a nosedive, which has caused problems for people who’ve got a lot of gilts, that’s government debt in their pensions. But what’s the attitude towards bonds now in the investment community, and how could one gain exposure to bonds in one’s Isa?

Timi Merriman-Johnson
Yeah. So just to explain what bonds are. So unlike stocks where you’re giving money to a company and getting part-ownership in that company, a bond is essentially the way a government or corporation raises money. So it’s more like a loan. And you can buy a bond, you can receive set of interest. You receive what’s called a coupon, which is a payment receipt for owning that.

Claer Barrett
I love that word. I mean, being a money-saving person, coupon has positive connotation to me.

Timi Merriman-Johnson
Yeah, they tend to be less volatile than equities, than stocks. And you typically see them used in retirement portfolios. The closer someone will get to retirement age, the more of a bond component you’ll see in the portfolio to help keep the price of the portfolio stable.

Claer Barrett
What would you add to that, Moira?

Moira O’Neill
So if you’re young and you’ve got many years ahead of you, most of your slice of your cake should be made up of equities with maybe a tiny bit in gold, a tiny bit in bonds. If you suddenly became more cautious or you need retirement or you moved into retirement, you might want to make it less risky and put more into bonds, less into equities.

Claer Barrett
How practically would both of you go about looking at the asset allocation in your Isas? Are there any tips that we can give people who are thinking, I’m not really sure what I have exposure to in my funds.

Moira O’Neill
The thing I always look at is something called the Pimfa indices. P-I-M-F-A.

Claer Barrett
Write this down, people.

Moira O’Neill
They show you what wealth managers in the City, what types of asset allocations they’re doing for their client. So it’s almost like a sneak peek into what really wealthy people get advice to do.

Claer Barrett
Looking at what the boffins have put in their home.

Moira O’Neill
Yeah. And you can see the spread of assets for different types of risk appetite. So cautious investors are being advised to do this. Medium cautious investors are advised to do this. And the gung-ho people who, you know, are willing to accept risk are doing it this way.

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Claer Barrett
Well, I’m going to come see some questions now from the audience. Interesting. We’ve got lots about tips for beginners on Isas. But I’m going to start with somebody who says, I’ve been wanting to open a stocks and shares Isa for a while now, this person says, but I don’t know where to begin looking. Any advice on making this process less scary or intimidating? Well, interesting choice of language.

Timi Merriman-Johnson
Yeah, and I speak to people all the time who feel this way. And I think to the person who asked that question, the practicality of signing up to an investment platform and opening stocks and shares Isa is very, very similar to opening an online bank account. You will share, like, very similar information. The process takes about the same amount of time, and the only reason why they find it scary is because it’s new to them. But hopefully, if they pick a platform that allows you to put in small lump sums or smaller monthly payments, if they feel more empowered to try different ones because you can now invest into, you can try a stocks and shares Isa and see how it works out for you. It’s like taking the amount of money that you’re happy to try out with and just get started and keep going. And if you do that, hopefully you’ll find that, like with what happened for us, investing is like a really fun rabbit hole that you can go down in. And as you learn and as you get more experience, it becomes more and more fun.

Moira O’Neill
Some people find it’s a rewarding hobby.

Timi Merriman-Johnson
Yeah.

Moira O’Neill
And in fact, they put aside play money in the end. So they have the main core investments and they have a bit of money on the side that they like to pick stocks and shares with and have fun with.

Claer Barrett
I love how you say fun. It could be fun. What specific advice would you give to that person sort of getting over the scared and intimidated bit?

Moira O’Neill
If you’ve got a friend who invests or a family member who invests, you could ask them about it and ask what they do and get them to show you how to do it. Or if you’re really, really scared and you just don’t know what to do, you could go to a financial adviser who will recommend a platform for you, who will set up the plan for you, who will do everything, but there’ll be maybe quite hefty fee attached to that. I think that because financial coaches aren’t regulated, it’s a bit of a wild west out there on social media. But in the end, besides, you know, open an account, put a little bit of money in and see how it goes. You don’t have to go gung-ho with thousands of pounds.

Timi Merriman-Johnson
£25 is a cheeky Nando’s.

Claer Barrett
Yeah, exactly. That is the catchphrase from the event: £25 is a cheeky Nando’s. The only thing I would add to that, and I do not mean for this to sound facetious: better stationery. One of the things that I found when I was trying to tackle my finances was that if I had a nice notebook or a nice A4 binder where I could keep things in, it just made me feel that little bit more sunny and positive when I got all of the financial paperwork out, having been someone who, at various stages in my life, has found it very intimidating to open post and deal with bills as I talk about in my book. It’s a really, really small thing, and it might sound quite stupid, frankly, to some people listening, but it was what got me over the hump. It’s been a pleasure spending our lunch hour with you. Do stay in touch with us all on Instagram and TikTok. I’m @ClaerB. Timi?

Timi Merriman-Johnson
I’m @MrMoneyJar.

Claer Barrett
And Moira?

Moira O’Neill
@MoiraonMoney.

Claer Barrett
And we really hope that you are now a step closer to sorting all of your financial lives out. See you back here soon.

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That’s it for Money Clinic with me, Claer Barrett, this week. For more tips on Isas and organising your money, you can sign up to my Sort Your Financial Life Out email series by going to FT.com/moneycourse. It’s free for FT subscribers and just £19 for everyone else. We’re always looking to chat with people about their money issues on the podcast, so if you’re interested in being part of a future episode, you can email us: money@ft.com. You can also take a peek at our website ft.com/money, grab a copy of the FT Weekend newspaper or follow me on Instagram and TikTok. I’m @ClaerB.

Money Clinic was produced in London by Tamara Kormornick and Persis Love. Sound design is by Breen Turner and our editor is Manuela Saragosa. You heard original tunes this week by Metaphor Music. And Cheryl Brumley is the FT’s global head of audio. And finally, our usual disclaimer. The Money Clinic podcast is a general discussion around financial topics and does not constitute an investment recommendation or individual financial advice. For that, you will need to find an independent financial adviser. That’s all the small print for now. We’ll see you back here next week. Goodbye.