With investment returns plummeting and most economists predicting a prolonged recession, investors could be forgiven for thinking that the last thing they should be doing is investing in an individual savings account (ISA). Such short-sightedness would, however, be misplaced.

The big attraction of ISAs is the tax breaks that they offer, and while these may
not be as attractive as they once were, the ability to shelter a portfolio from the twin
burdens of income tax and capital gains tax is significant.

Of course, as with any tax-efficient investment, the attraction seems much less when markets are heading downwards, and ISAs, like PEPs before them, can be a major source of frustration when they are sheltering losses that can’t be used to offset CGT liabilities elsewhere, rather than gains.

Too good to miss
But even in these depressing times, the ISA is an essential tool that the private investor
should seek to make maximum use of. Not only is there no income tax to pay on the yield from your ISA investments, but there is also the opportunity to lay the foundations for tax-free gains in the future.

It is not simply a case of appreciating that the recession will not last for ever, that, at
some point, markets will recover and that current valuations will be seen to have been
incredibly cheap. Investors also need to realise that the way to make maximum use
of the ISA allowance is to ensure that they use as much of it as possible each year.

Because the ISA rules are based on each single financial year – investors are permitted
to put up to £7,200 into an ISA each tax year – there is a tendency to focus on this as a
maximum investment level. But we all get a new ISA allowance each 6 April, and consistently making contributions to our ISAs year after year will result in a sizeable, and tax-efficient, portfolio.

Sizeable investments
As one wealth manager points out in our review of managed ISAs on page 68, ISA portfolios in excess of £100,000 are not unusual, and some ISA investors have much
larger sums within the tax-free wrapper.

These portfolios have been built up over more than 20 years, starting with the very
restricted early PEP schemes, by people who have sought to take maximum advantage of the increasing investment limits and flexibility that has been introduced over time.

For it is important to consider your ISA investments in their entirety.With the ability to consolidate all your PEP and ISA holdings into a single ISA portfolio, which can then be actively managed according to your own circumstances and prevailing market conditions (restrictions on cash holdings not withstanding), most investors now have the opportunity to shelter a significant proportion of their total portfolios from income tax and CGT over time. But if this is going to happen, you have to continue to take advantage of your ISA allowance every year, irrespective of the short-term outlook for markets. Those investors
who are continuing to put defensive investments into their ISAs will reap the rewards when the current recession is receding into history.