Can tax-free savers become millionaires?

ISAs allow you to build up a fortune and avoid paying tax on the proceeds

If you had made full use of your tax-free savings allowance every year since personal equity plans (PEPs) were launched in 1987, you could have more than a million locked away from the clutches of the taxman by now.

But you would have only achieved that landmark figure by careful investment – pick the wrong funds or shares and you could be sitting on a substantial loss.

Analysis by number-crunchers at FundExpert.co.uk for The Independent shows that investors could have salted away £192,480 by using all of their their tax-free savings allowance in the last 25 years. The current annual limit allowed in an Individual Savings Account (ISA) is £11,280 but it started at just £3,000.

Over that time period that amount of cash invested in the FT-SE 100 would have grown to £514,000. But if it had been invested every year in the Fidelity Special Situations fund it would have grown to £1,160,000 by the end of the last 2011-2012 tax year.

Meanwhile, if you had invested your PEP and ISA allowance every year in Neil Woodford's Invesco Perpetual High Income fund - which has just celebrated its 25th anniversary - you'd be sitting on £990,098, according to calculations by Chelsea Financial Services. So becoming a tax-free millionaire seems simple - just choose the right fund and stick to your guns. But's that's not necessarily the right approach, according to Brian Dennehy of Fund Expert.

"The numbers highlight the importance and power of regular investing," he said. "Investing even a small amount regularly is not only a good savings habit, but your portfolio benefits from the positive effects of pound cost averaging and the power of compounding.

"But I wouldn't recommend an 'invest and forget' approach - the key is to be in the right fund. If you are the rewards can be huge. But investors should review their holdings regularly."

Anecdotally it's reckoned there may only be 30 ISA millionaires, and those that have made it are those who have been prepared to make regular changes to their holdings rather than sticking with potentially losing investments.

Tom Stevenson, investment director at Fidelity, puts it: "If you can accept the higher volatility of shares when compared to cash savings, the returns from stock market investing over time can be considerable. Starting early really can make a big difference – it gives your money more time to grow in the market and to benefit from the magic of compounding."

Darius McDermott of Chelsea Financial Services advises those looking to build up a tax-free fortune: "To become an ISA millionaire, invest every year, don't over- diversify, reinvest dividends, and review at least once a year if not twice."

The other key about ISAs, of course, is their tax-free nature. There's no capital gains tax due on your hopefully growing fortune.

"ISAs are a fantastic use-it-or-lose-it tax perk," pointed out Mr Stevenson. "That's why they're popular with investors who understand the powerful impact avoiding further income and capital gains tax can have on their total return."

Brian Dennehy adds: "More than anything the ISA millionaire numbers show the benefits of protecting your capital within an ISA – these capital gains are lining your pockets and not the taxman's!"