Become an ISA Millionaire (Starting in 2012/2013)
How a person or a couple can use their ISA allowances to build a pot of money worth over £1,000,000 and details as to how long this might take. This is an updated version of the original article for the financial year 2012/2013.
Preliminaries - ISA to millionaire
ISA refers to the UK's Individual Savings Account. It is a tax-free package for savings and investments. For the tax year 2012/2013, UK residents have the option to invest £5,640 in a cash ISA and £5,640 in an investment ISA. Alternatively, you could invest all £11,280 (or as much as possible) into an investment ISA. For the purposes of this post those outside of the UK will have to refer to any tax-free package that the government offers but the principles are still the same. |
| Click to download ISA Millionaire spreadsheet (.xls) |
Millionaire Theory
The first column in the table assumes that you are one person saving to become a millionaire. You invest your full ISA investment limit (£11,280) into an index tracker, well picked shares, fund or share related product. You reinvest your full ISA allowance each year, topping up the total pot. As you can see in the cell labeled "growth", I have assumed an annual rate of return of 7% per year. This is a very realistic return (after inflation) from shares for an investor of average intelligence and relatively minor experience. As you move down column B you can see that the interest is compounded each year and you are topping up the amount saved. In cell I2, you can see that it has taken you 29 years to become a millionaire and from J2 you can see that you have only actually invested £327,120 of your own money to become a millionaire, the rest is from the magic of compounding.
Theoretically, you could become a millionaire even quicker. If you look in column C you can see that I have used a couples ISA allowance which is double a single person's allowance, at £22,560. A married couple could invest this each year and build up a pot worth over one million in 21 years time. They would have had to invest a total of £473,760 of their own money to do this, however this is only £236,880 each.
Why would you want to become an ISA millionaire?
Other than the fact that you can boast about how you're a millionaire, there is a very important reason to do this. Imagine a couple both aged 25 who do this. They save hard and invest intelligently and patiently. After 21 years they are both aged 46, they can retire. Why? Because they are earning a household income of over £70,000 per year and it's all tax free. Furthermore, if the couple were patient enough to save for another 8 or 9 years they could be seeing return of £140,000 per year, tax free, for the rest of their lives and they would only be 55. This would be a very comfortable retirement. It's so simple, why isn't everyone doing this? Because it's simple but not easy.Millionaire Practicalities
There are many things that can get in the way of becoming an ISA millionaire but there are some solutions to some of these problems:Returns: You may not be a shrewd enough investor, the market might collapse, there is no way to guarantee those returns? On the contrary I believe I have been stingy with those returns. Firstly, I have not assumed any reinvesting of dividends (if investing in shares). This would give a huge boost to savings each year and hopefully reach the goal line faster. Secondly, if you take a long enough time line, say 20 plus years (which we are), shares yield a historical average of at least 7%. Even if you're not very good at picking share you could simply choose to invest in an index tracker to track overall markets, which should yield you this return.
Fees: These refer to the fees that you pay your broker or fund manager and can be considerable, eating away at the compounding effect. To avoid large fees choose an on-line share dealership that you manage yourself or choose an index tracker which tends to be relatively cheap.
Savings: A legitimate worry would be that a person cannot hope to save that much each year. If you have dependants to bring up as well it can be even harder to find the spare cash to invest. An easy solution would be for a couple to invest together in one person's ISA allowance. This is very realistic. If you assume that the average annual income in the UK is £26,000 a year which means that a combined household income of £52,000 would be investing about 20% of their income into investment ISAs. 20% is what people should be saving anyway making this goal extremely plausible.
Some of you will retort, "but I don't have a spouse/partner?". This shouldn't stop you reaching this goal. There is no reason why you can't pair up with some friends to reach the same goal. It would be a little bit more complicated and would require a lot more care when setting up contracts etc, but still it is possible. I will write a post on this another time.
If ISAs change: I believe that now that ISAs have been in existence for a while, the allowance will not go down in value. It would be political suicide to do so or to remove them without replacing the with something equally as attractive. This is because it would be viewed as anti-poor as the original idea was to encourage the poorer members of society to save. A country needs to encourage saving to grow (I will not go into the economic explanation here, message me or comment if you would like to know more) and all governments know this.
Conclusions
In theory anyone can become a millionaire. The only question is whether or not you have the patience or are able to make the sacrifices.
What do you think? How plausible is this scheme? What other schemes exist to make this sort of tax-free income?
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