The £2,220 ISA mistake: are you making it?

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only. ISA eligibility and tax rules apply.

A keen and organised house-hunter in the UK, who earns the average salary of £39,039, has given themselves 10 years to save up for a house deposit. They plan to invest £300 each month, hoping to achieve an average annual return of 7% in line with the long-term historical average of the S&P 500 index before fees and currency effects.

On that note, to keep their planning stage simple and hypothetical, they exclude fees for things like accounts and funds. We’ll also assume they’ve chosen a growth strategy over an income one (although we’ll revisit the example with a nod to income later too).

Fast forward a decade and when they sell, all being well, their plan of compounding returns has meant the £36,000 they invested has turned into £51,335, a capital gain of £15,335.

Now, this is where the account they used to accumulate those gains really matters. In a stocks and shares ISA, it’s really quite straightforward - there would be no UK capital gains tax (CGT) or UK dividend tax applied. That’s the beauty of the tax-efficient account. The added bonus is no paperwork, online portals or spreadsheets to contend with.

In a general investment account (GIA), we’d have to consider how that £15,335 gain is considered for UK tax. For that we need a couple of things, namely how this person’s income affects which capital gains tax band they fall into, and the rates they face on their gains. As we’ve said, their strategy hasn’t been about dividend compounding so we can leave that part out.

So, to the maths.

But first, an important admission - while we’re laying out an imaginary case study, all the calculations and permutations you see are for purely informational purposes and neither you nor our imaginary friend should construe them as tax advice. If in doubt, chat to an independent financial adviser.

Step 1: income

First, let’s revisit our investor’s income - it’ll help with our CGT sums later on.

• Salary: £39,039
• Personal allowance: £12,570
• So, taxable income: £26,469

This person’s income sits well below the £50,270 basic-rate band ceiling.

Step 2: CGT rate calculation

We now have to ask how much of that range is left excluding the personal allowance because the personal allowance only applies to income, not gains:

• £50,270 - £26,469 = £23,801

Step 3: Capital gains are stacked on top of taxable income

We all have a £3,000 capital gains allowance for the 2025/26 tax year. If we sell investments for a profit which tops that limit (bravo) we need to pay tax on the gain above that level.

For basic-rate taxpayers, the rate is 18% in the 2025/26 tax year. For higher and additional-rate taxpayers, the rate is 24%.

In this case the taxable gain is:

• £15,335 - £3,000 = £12,335

As the whole gain sits within the £23,801 range we mentioned earlier, all of this will be taxed at 18%.

• £12,335 x 0.18 = £2,220.30

A few things to point out here. First, that’s a big portion of the overall gain (14.5% to be exact) to wave goodbye to when you’re planning to put a deposit down. What’s more - we haven’t considered that this person hasn’t had a pay rise in a decade. If they were to become a high-rate or additional-rate taxpayer - or part of their capital gain were to spill over into the higher CGT rate band - they’d be paying even more in CGT.

I said we’d come back to the dividend side of things and come back we shall.

Let’s now assume our investor followed a total return strategy made up of that same target of 7% average annual returns (still hypothetical but in line with the S&P 500’s history) with 3% coming from dividends and 4% from capital growth. That dividend yield is broadly in line with what many global equity income funds aim for.

We’ll assume these dividends are paid out annually and not reinvested i.e. when they are paid out, they land as cash in the account and don’t contribute to portfolio compounding.

For the 2025/26 tax year:

• Dividend allowance: £500
• Dividend tax rate for basic-rate taxpayers: 8.75%
• Dividend tax rate for higher-rate taxpayers: 33.75%
• Dividend tax rate for additional-rate taxpayers: 39.35%

While our investor only really has to deal with CGT when they sell their investments, the nature of dividends (i.e. the fact that they’re paid out regularly) means we have to consider whether we have to pay tax on them in each tax year.

When does UK dividend tax kick in?

Given UK dividend tax usually applies as soon as annual dividends exceed £500, at a 3% yield that happens once the portfolio reaches roughly £16,700:

• £16,700 x 0.03 = £501

At this rate, our investor would cross that mark during the fifth year of investing. In that year, gross dividends of just over £600 would mean £108.36 is considered for tax:

• £108.36 x 0.0875 = £9.48

By year 10, our investor would be paying around £75 in dividend tax, with cumulative tax payments of around £250 for the decade. Again, while it would take a lot for a dividend journey like this to push them into the higher dividend rate band, if they extended their timeline, saw higher growth or purely focused on a dividend strategy, eventually they might tip into paying a lot more tax along the way. More realistically, this person’s career might naturally take them into higher income tax bands, in which case the tax efficiencies offered by the stocks and shares ISA become even more pronounced.

None of this is meant to be tax advice or a guide to tax planning, far from it. There are so many variables (inevitably yielding a whole spectrum of results) that the main takeaway isn’t really the specifics, it’s the general theme. And that theme is just how big a burden can emerge, both from an admin and tax perspective, simply by not making the most of a stocks and shares ISA. We often hear about the account’s tax efficiencies but here they are in black and white - and while we all need to decide if any account is ultimately right for us, it’s always worth putting pounds and pence into those deliberations.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.

Robinhood doesn’t provide tax advice. You should seek advice if you have any questions regarding the impact your investments will have on your income tax and tax filing requirements.