If you are one of those people who is always racing to use up your tax allowances, such as Individual Savings Accounts (ISAs) at the last minute before the end of April 5, then you are not alone. But you could be making a big mistake.
When it comes to mopping up tax allowances, it is best to use your allowances at the beginning of each tax year than the end. If you have not managed to use all or any of your allowance coming up to April 5, well, it is better late than never. But if you can take advantage of using your ISA allowance, for example, at the start of the tax year, then you will benefit from an additional year of investment growth.
It may not seem like it matters that much, but that extra period of growth – assuming markets rise over the year – will add up over time. Even if the markets dip, the adage ‘it’s about time in the markets, not timing the markets’ still holds because trying to time the market is usually not a good idea.
In addition, you get a full year of growth that is free of capital gains tax and free of income tax. By holding your assets outside of an ISA for the year, you could face a tax charge on any dividend payments from equities.
Starting to use your allowance at the start of the tax year also gives you other benefits. You can choose whether you put the entire £20,000 allowance into your ISA in one go, or whether you ‘drip feed’ money into the market over the full 12 months.
The latter can be an effective method to help smooth out ups and downs in the stock market, known in the trade as ‘pound-cost averaging’. Let’s take an example of you putting money into a unit trust. If you are buying units every month with the same amount of money, you will be buying more or fewer depending on the value of the units you are buying that month.
These values will go up and down depending on a number of factors that impact the stock markets – everything from political will to social and economic changes.
The same principle applies to your pension allowance – most people can put up to £40,000 a year into a pension and get tax relief – if you can put money aside to go into your pension each month, you are benefiting from the same investment smoothing process outlined above.
The other drawback of waiting until the end of the tax year to use your allowances, is that you are forced to put a lump sum into markets at what could be a terrible time. So, giving yourself a head start means you can benefit from the highs and the lows over the year.
If you want to find out more about how you can benefit from your ISA and pension allowances by taking action early, get in touch with us now and see how we can help you.