My $100m tax-free account?Posted: 2015-06-15
One of the best tax-breaks in the UK is the Individual Savings Account (ISA). Each year every adult can invest up to £15.24k (rising with inflation) in one of these accounts. Any income or gains in these accounts is tax free, and doesn’t even need to be reported on the tax return. Awesome.
£15.24k might sound like a lot of spare cash to find, but in reality what this means is selling £15k of existing assets and funnelling them as soon as possible (every April 6, at the start of the idiosyncratic UK tax year) into your ISA. Sure, you take the transaction fee hit, but you then get indefinite tax free income and gains. This is a no brainer. Allowances are use-it-or-lose-it and once you withdraw your funds (and – STOP PRESS from the last budget – don’t put them back again in the same tax year) those withdrawn funds lose their tax-free status for good.
And while UK governments in the last 10 years have been inveterate tinkerers with savings and pensions, the regime for ISAs has only changed in a positive direction – to enlarge the annual allowance, and to improve the inheritance treatment. So ISAs feel like they are reasonably predictable over a decade or two. And £15k per year, for a decade or two, quickly amounts to some real money.
I have always admired the FT journalist and Lord of the realm, John Lee, for becoming one of the UK’s first ISA millionaires. I aspire to equal his achievement, admittedly measured by a much weaker pound than when he reached this milestone some years ago. But they say the first million is the hardest, and compound arithmetic suggests that I can do far better than becoming an ISA millionaire. How much better?
Currently the ISAs of Mr & Mrs FIRE are worth about double what we have invested in them (and would be worth more if I’d started earlier – I kick myself for not getting aggressive with my ISA allowance until a few years ago). We now max out every year’s allowance, moving over £30k this tax year into our ISAs. We tend to do this every April, to get the maximum benefit from the tax-free returns that ISAs provide. We’ve now reached a point that across our various ISAs that we have about £330k invested. Some way behind John Lee, but a useful nest egg nonetheless.
Using a retirement planner, what happens to our £330k? I have simplistically assumed that Mr & Mrs FIRE are one person, with a double-size ISA allowance, an average age of 43, and an average life expectancy of 88 (though this person has a one in four chance of reaching 96). I then assume we take ‘Above Average Risk’, which works out as 9.5% average annual return; this is lower than my last 3 years’ return but roughly in line with my 10+ year return. The retirement tool assumes, unreasonably conservatively, that my annual contributions don’t rise over time (whereas HM Govt has been indexing the annual limit recently). I also assume we never need to touch any of this money; we would spend taxable funds first.
What our retirement calculator spat out: these funds grow to £28m ($43m) by our (joint) death in 2060. But in 10% of scenarios, they grow to at least £83.6m ($130m+). Holy shmokes. This doesn’t allow for inflation (currently negative in the UK) but as a headline number it’s still pretty impressive. Still OK to assume that the ISA tax break remains untouched until 2060 then, are we?
Even assuming a more conservative 6% average annual return, which is probably more like what we can expect after inflation, our £330k still becomes £10m (in today’s money!), with a 10% chance of exceeding £13.6m by 2060. If I/we do fulfil my/our 25% chance of becoming 96, then our ISA would be worth £15.7m (on average), and maybe (10% chance) £22.5m.
As Monevator points out, the best investors are all dead. What if I/we don’t live until 88, let alone 96, but instead barely scrape through to 65? We still cruise past that ISA millionaire status. We’ll have, in almost all scenarios, at least £2.2m – and conceivably more than £5.7m. That’s assuming 8% return per year – which relies on a hefty equities allocation, but is less than I’ve averaged over a sustained period.
If these numbers don’t get you salivating over investment returns, what would?
P.S. I noticed in April 2018, three years after posting this, that the screenshot above appears to be incorrect; I think it is showing the settings for Below Average Risk and I hadn’t re-run for Above Average Risk; re-running the same model 3 years later produces the result shown below: