If you’re a high earner, you’ll be keen to know how to use ISAs to save and reduce tax. If you’re not already aware, Individual Savings Accounts (ISAs) are one of the most effective tools for building a tax-efficient investment portfolio in the UK.
They allow you to save and invest money without paying income tax or capital gains tax (CGT).
Whether you’re seeking to invest efficiently or are simply looking for an investment edge, using ISAs to save tax is highly recommended.
For context, this article mainly focuses on the role they play for higher income earners in the UK.
Related reading: Are pensions a tax efficient investment for higher earners?
What will you learn?
- What ISAs are and how they work
- How they can help you save tax
- The different types of and their benefits
- How they can reduce CGT
- If ISAs or pensions are better for tax efficiency
What is an ISA & how are they tax efficient?
An ISA is a tax-free savings and investment account available to UK residents.
By contributing to one, you can save or invest up to the annual allowance without paying tax on the gains, interest, or dividends. This makes them an attractive option for savers looking to benefit from tax free growth.
They are a solid way for higher rate taxpayers to invest tax efficiently and to mitigate the growing burden of taxation on higher earners.
The Autumn Budget 2024 reduced the Capital Gains Tax (CGT) annual exemption, increasing taxable gains for higher earners.
In shifting the onus of those with assets the importance of tax-efficient investments like ISAs to shield profits and reduce CGT liabilities, has become more pressing.
Five ways ISAs save and reduce tax
Later in this article, we’ll highlight some in depth examples of how ISAs offer tax efficiency for UK savers.
For now, here’s a quick summary:
- No tax on investment profits or capital gains
- Tax-free interest earned on cash savings
- Dividends received without any tax deductions
- Government bonus of 25% on Lifetime ISA contributions
- Flexibility to withdraw without losing tax-free allowance
Now let’s take a look at the current annual allowance for ISAs, the different types available to UK savers, and some examples of how high income earners use ISA to reduce tax.
What is the current annual allowance?
The annual ISA allowance is currently £20,000, and the tax year runs from April 6th to April 5th.
It’s important to note, any unused allowances can’t be rolled over into the next year. Therefore, it’s important to make the most of this tax-free allowance where you can,
Furthermore, your allowance can be split across various types of ISAs, providing flexibility to suit different financial goals.
The tax-free growth within them makes them particularly attractive for building wealth without paying unnecessary taxes.
What are the different types of ISAs?
There are a range of options available to UK savers covering:
- Cash ISAs
- Stocks and Shares ISAs
- Innovative Finance ISAs
- Lifetime ISAs (LISAs)
- Junior ISAs
How to use ISAs to save tax and build wealth
For many higher income earners, ISAs are one the main components of a tax efficient investment portfolio.
Here’s a concise overview of the different types available for UK investors and savers.
Stocks & Shares ISA
- Higher-rate (40%) and additional-rate (45%) taxpayers pay no CGT on investment profits
- No tax on dividend income, saving up to 39.35% for additional rate taxpayers
- Zero need to declare ISA investments on tax returns, reducing administrative burden
- Unlimited withdrawals with no tax implications
- Can transfer between platforms while maintaining tax-free status
Cash ISA
- Interest earned is completely tax-free
- Highly valuable for higher rate taxpayers exceeding £500 personal savings allowance
- Interest doesn’t count toward the income threshold for tax bracket calculation
Innovative Finance ISA
- P2P lending returns of 6-8% completely tax-free vs 40-45% tax on standard P2P investments
- Interest earned doesn’t affect personal savings allowance
- Ability to combine a mixture of other ISA types within the annual £20,000 allowance
- Tax-free returns are typically higher than Cash ISAs
The Lifetime ISA (LISA)
- 25% government bonus (up to £1,000 yearly) regardless of your tax bracket
- Tax-free growth on investments or savings
- There’s no tax on withdrawals after you’re sixty, however, there are penalties if you do so before
- They are often used alongside pensions for maximum tax efficiency
- Particularly valuable for those hitting pension annual allowance limits
Related reading: Individual Savings Accounts (GOV.UK)
Are there any disadvantages to investing in an ISA?
It’s clear, that using ISAs to save tax, is highly effective for high income earners.
That said, it’s important to understand their limitations so you can make an informed decision on the best route to explore.
Here are some key considerations:
- The annual allowance is limited to £20,000, restricting higher contributions
- No upfront tax relief like pensions offer for high earners
- Lifetime ISAs carry penalties for early withdrawals
- Stocks and Shares ISAs involve market risks with no guaranteed returns
- No employer contributions compared to workplace pensions
- Investments within ISAs can be limited by the provider’s offerings
If you get to grips with these considerations, you can weigh the benefits of ISAs against other tax-efficient investments such as pensions or VCTs. This will allow you to take a holistic approach to your tax saving plans.
Which ISA is best for those in the higher tax brackets?
Of course, the answer to this question will vary from person to person, and situation to situation.
Therefore, this section is simply a guide to highlight a couple of the most appropriate ISAs for those in the higher tax brackets.
Stocks & Shares ISAs
Stocks and Shares ISAs are often the most advantageous for higher income earners. They allow you to grow your wealth without paying income tax on dividends or CGT on gains.
Over time, this can significantly boost your investment returns, by providing you with tax free growth.
LISAs
If you’re a higher rate taxpayer another option is the Lifetime ISA.
Why?
They benefit individuals saving for a first home or retirement.
How?
The government pays a 25% bonus immediately increasing the size of your investment portfolio. .
However, if retirement is the main priority, high earners would be well advised to make the most of their pension contributions, as these provide even greater long term tax advantages.
Should I also invest in a pension?
As mentioned above, while ISAs offer tax-free savings and flexibility, pensions provide upfront tax relief. Also, over the long term, pensions will accrue compound interest offering significant growth and investment returns over time.
Of course, whether you feel you should invest in a pension is a personal choice and should be aligned with your retirement and investment goals.
Therefore, making them one of the most tax-efficient investments available for people planning for retirement.
For higher-rate taxpayers (40%), every £1,000 contributed to a pension costs just £600 when tax relief.
Combining them with pensions creates a balanced approach.
Use ISAs for short- to medium-term goals and pensions for long-term retirement planning.
Together, they provide flexibility, growth, and tax efficiency.
Using VCTs to save tax
Venture Capital Trusts (VCTs) offer attractive tax benefits.
These include:
- 30% income tax relief
- Tax-free dividends
However, VCTs carry higher risks, as the companies they invest in are often in early growth stages.
For high earners seeking diversification and tax savings, VCTs can be valuable but require careful consideration of your:
- Risk tolerance
- Financial goals
- Capacity for loss
As a result, professional advice is key to ensuring you approach these investments with a balanced understanding of the facts.
Related reading: Are VCTs a good investment for high net worth individuals?
Summary: Using ISAs to save tax
Using ISA as part of your tax efficient investing strategy is essential for high earners and anyone looking to grow their wealth while minimising taxes.
By using all of your annual allowances, choosing the right ISA types, and integrating them with pensions and other tax-efficient investments, you can build a solid investment plan.
For high-income earners, ISAs offer excellent opportunities for tax-free savings and growth.
Factors to consider
- Are you using all of your £20,000 yearly ISA allowance?
- Which type of ISA best suits your financial goals and risk tolerance?
- How will they fit into your broader tax-efficient investment strategy?
- Are you paying into a pension for long-term tax efficiency?
- How can you maximise the tax-free growth potential of your ISAs?
Questions you may ask about using ISAs to save tax
Looking for more clarity? Read the below answers to a selection of helpful FAQs.
That’s a question we are often asked, however, the answers depend on so many factors. Consult a financial adviser to get a clearer picture.
Yes, the current annual ISA allowance is £20,000, which you can allocate across the different different types mentioned in this article. Using ISAs to reduce tax on savings and investments allows you to build wealth without paying income tax or capital gains tax. This makes ISAs an incredibly effective way to reduce tax.
Contributions exceeding the £20,000 annual ISA limit lose their tax-free status and may incur penalties. Excess funds might be treated as taxable investments, subjecting any positive returns to income tax or capital gains tax.
No, ISAs are tax-free, so there’s no need to include them on your tax return. This contrasts with pensions, where higher- and additional-rate taxpayers must claim tax relief through their tax returns.
Yes, ISAs are available to all UK residents regardless of income level or tax bracket. High earners and higher-rate taxpayers benefit significantly from ISAs as they provide a legal way to reduce the growing tax burden on dividends and capital gains.
Yes, high net worth individuals (HNWIs) often use ISAs as part of their broader tax-efficient strategy. Although, their impact is limited for those with considerable wealth.