We reveal how much you need to save over time to maximise your ISA allowance and end up with £1million
If you dream of becoming an ISA millionaire then you’re not alone. New data reveal that there are now nearly 5,000 ISA millionaires in Britain, with the top 25 averaging a staggering investment wealth of £8.8m.
If you’re new to investing, reaching those dizzying heights might seem like a pipe dream. But it’s surprisingly achievable with dedication, hard work and an awful lot of patience.
So, how much do you need to save to become an ISA millionaire? Experts have crunched the numbers.
How much do you need to save?
Time is a key factor in investing so building significant ISA wealth is much easier if you’re in your twenties or thirties.
A young investor aged 20 could reach £1mn by retirement by investing £4,400 every year, according to figures from investment platform interactive investor.
Meanwhile, a 30-year-old could become a millionaire by investing £8,200 each year up to retirement age.
The later you start, the more you need to invest, with a 40-year-old needing to stash away £16,400 in their ISA every year to reach £1m by retirement.
The figures assume you invest in a stocks and shares ISA, achieve annual investment growth of 5 per cent and increase your contributions by 2 per cent each year in line with inflation.
Myron Jobson, senior personal finance analyst at investment platform interactive investor, explains that “time in the market is your best friend when it comes to building wealth.
“The sooner you start investing, the more you can harness the power of compounding returns, making it significantly easier to reach the coveted ISA millionaire status.
“It’s also encouraging that you don’t need to use your entire ISA allowance of £20,000 each year to become an ISA millionaire. Because time is the most crucial factor here, younger investors can achieve impressive results even when starting with surprisingly modest amounts.”
He adds: “Consistency is key – regular contributions, even modest ones, can snowball over the years into a substantial pot, especially with the generous tax benefits ISAs offer.”
Investment compounding can supercharge your wealth
As stocks and shares tend to grow more than cash, you’re more likely to reach £1m with a stocks and shares ISA rather than a cash ISA.
Sarah Pennells, consumer finance expert at Royal London, said that “over the longer term, stocks and shares investments tend to deliver higher returns than cash, but returns are not guaranteed.
“You also have to be comfortable with the ups and downs of the stock market – some of which we are seeing at the moment.”
Over time, returns on your stocks and shares can start to snowball, through a process known as investment compounding.
“Compounding is sometimes described as the ‘eighth wonder of the world’,” says Pennells. “Through compounding, the return your stocks and shares ISA makes from rises in the price of your investments, and through dividends being paid by companies the fund holds, generates its own return.”
Why use an ISA to invest?
The beauty of using an ISA to invest is that you can escape tax and keep more of your wealth, which is especially valuable as your wealth begins to grow.
Investments held inside an ISA are completely free from tax on dividends, interest and capital gains tax on any profits from selling shares.
Jobson explains that “it’s vital to invest inside an ISA wrapper because extra costs like tax can be a huge drag on performance, eroding your wealth over time.”
Someone who earns £10,000 dividend income outside a stocks and shares ISA would have to pay £831 dividend tax each year if they pay basic rate tax and £3,206 if they pay higher rate tax.
But time is running out to use this year’s £20,000 ISA allowance before it resets on 6 April.
Pennells says: “Everyone who’s eligible for an ISA has the same limit, but it runs out on 5 April every year and you cannot carry it over. If you’re married or have a partner, you could boost your tax efficiency as a couple by making sure you’re both using the allowance.”
“Anyone who’s aged 18 or over and resident in the UK can open an ISA, and you can save or invest up to £20,000, either putting it all in cash, all in stocks and shares, or splitting it.”
How to decide if using an ISA or savings account is better for you
With fixed accounts – where you lock away your cash for a set period of time – the interest is generally better on typical savings accounts than with ISAs.
At the moment, for example, the best two-year fixed ISA is with Cynergy Bank, paying 4.44 per cent, whereas with an easy access account you can get 4.76 per cent from Chip.
According to MoneySavingExpert.com, there is a method to help you compare normal savings accounts and cash ISAs, to decide which is better (assuming you will pay tax on your savings). Take the rate on the ISA you are looking at and multiply it by:
- 1.25 if you’re a basic-rate taxpayer
- 1.66 if you’re higher-rate taxpayer
- 1.82 if you’re a top-rate taxpayer
The result of that sum is the rate you need to get on a normal account for it to be a better option that your ISA. If normal savings don’t pay more than that, then you’re better off in the cash ISA.
As a result, for those who have not used their ISA allowance, the ISA is still a better bet than typical savings.