Stocks and Shares ISAs are a great way to save for the future. However, if you are thinking about opening one of these products soon, there are a couple of things you should know before you start the process.
Stocks and shares ISAs allow you to save up to £20,000 per tax year, but you need to be careful you don’t go over this limit.
There are also restrictions on how many of these products you can open. There are four main types of ISAs: Cash ISAs, Stocks and Shares ISAs, Innovative Finance ISAs and Lifetime ISAs. In theory, you can open one of each every year. Just make sure you don’t go over that £20,000 contribution limit. Doing so can attract tax penalties.
What’s more, this is a ‘use it or lose it’ annual limit. So even if you only have a few hundred pounds to save, it is worth taking advantage of the allowance before it disappears.
Watch those withdrawals
Another thing to keep an eye on with a Stocks and Shares ISA is withdrawals.
It is possible to make as many withdrawals as you want from an ISA in any given year without tax implications. However, putting money back in is a different question.
Some providers offer flexible ISAs. These allow you to deposit and withdraw money as long as the total deposit amount does not exceed £20,000. Other providers don’t offer this option.
So, if you deposit £100, withdraw the money and then deposit another £100, this will total £200 of deposits and eat into your allowance.
Don’t lose money
With a Stocks and Shares ISA, you can invest your money in virtually any country around the world. This doesn’t mean you should.
The best way to make the most of your ISA is to invest sensibly and avoid losing money. Because you are going to contribute £20,000 a year, it is not possible to go back and top up past years if you end up losing a lot of money.
The impact this can have over the long term is significant. Let’s say you invest £20,000 via a Stocks and Shares ISA in a low-cost FTSE 100 tracker fund.
Since its inception, the FTSE 100 has produced an average annual return of 9% including dividends. I’m going to use this figure as a benchmark for returns in this example.
Over the space of a decade, the initial £20,000 investment would be worth £49,000. Using the FTSE 100 current dividend yield of 4.3%, this suggests the investment would produce a tax-free income stream of £2,107 a year.
On the other hand, if you invested £20,000 today, but immediately lost 50% before investing the remainder in the FTSE 100, the final figure would be just £24,500. This would give an annual tax-free income of £1,050.
That is why it is vital to avoid taking too much risk with ISA investments. The best way to grow your wealth over the long term is to buy a low-cost passive tracker fund, as explained in the example above.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.