Introduction
I’ve been a financial adviser for more than 20 years and one thing I’ve noticed is that people often get confused about the building blocks we use to put together a cohesive portfolio. In the last blog series, we talked about the main accounts you need, pensions and ISAs, and in this one, I want to build on that and add some detail round the side too.
Most People Only Need a Pension and an ISA
In the introduction to these blogs, I said that I wanted the Ultimate Guide to be for the masses, not for the few. I tend to find I get the most questions from the extremes of folks – either those who are getting started or those with real niche needs because they’re high earners, or have trust funds or whatever. I spend my days working mostly for the latter, inevitably.
The vast majority of people though, fall in the middle of the bell curve, the normal-est of normal people. And those people mostly just need a pension and an ISA. Given that the last series was mostly about what you need to do as an investor, I sketched over the main types of ISA, so let’s dig a little deeper. there are four types:
Cash ISAs – these are simply tax-free bank accounts, so you pay absolutely no tax at all on the non-existent level of interest you’re getting. Think about this. The first £1000 of interest received on any money you have in the bank or building society is tax free anyway.
If you’re lucky enough to have can account paying you 1% interest, that means you have to have more than £100,000 in the bank to get anywhere near paying tax on your interest. So Cash ISAs are basically not worth considering.
Lifetime ISAs – these are a special kind of ISA with a £4,000 annual contribution limit. Whatever you put in, the government makes up by 25%, so if you put in the full £4k, Rishi Sunak will make it up to £5,000. That’s a super-useful benefit – we like free money!
The quid pro quo, as they say in Bradford, is that you can only use this money for two purposes. Buying your first house or for using after age 60. If you take the money out for any other purpose than this, you’ll have to pay a penalty of 25% of whatever you take out.
This penalty was temporarily reduced to 20% until April 2021 to account for the fact that many people needed access to their Lifetime ISAs during the COVID crisis. Lifetime ISAs can either be held in cash or stocks and shares.
Stocks & Shares ISAs – Now we’re talking! These are the bread and butter ISAs loved by wealth-builders everywhere. In an S&S ISA you can invest in funds, directly held shares, ETFs and all kinds of cool things.
You pay no income tax on dividends, and no capital gains tax on any money you make when the money grows. They are super-flexible and usually completely accessible without penalty. Watch for dealing fees depending on what you’re holding in your ISA.
And finally we have Innovative Finance ISAs – these are special ISA wrappers set up to hold peer-to-peer lending investments. I’m not a huge fan of P2P unless it’s for a tiny amount of money relative to the whole.
In recent times its weaknesses have been shown as there has been a huge increase in defaults by borrowers and this has meant that some people are having a helluva job getting their money out. Not a problem if you can afford to wait your turn, but a huge issue if you’ve bet the farm on P2P.
Most of us will need to use ISAs to some degree. You should largely discount cash ISAs and Innovative Finance ISAs, but the S&S ISA and the Lifetime ISA are where most of us need to concentrate our efforts.
Then we have our pensions, which fall largely into occupational and personal camps.
Occupational schemes are either defined benefit (DB), where you get a guarantee of a future income based on your salary and the length of your membership of the scheme, or they are defined contribution (DC), where you and your employer pay into a fund, and what you get at the end depends on how much goes into the fund and how well it grows.
Personal schemes are always defined contribution – there’s always a fund involved – and it’s all about maximising the level of that fund over time so that it’s a useful amount when you’ve had enough of working for a living. Pensions can’t be accessed before age 55 and that is rising after 2028 to the state pension age minus ten years. Basically, for the vast majority of the population, those two accounts, a pension and an ISA are all you need.
And, a SIPP is a self-invested personal pension. These days SIPPs are commonplace. The term is used to denote a pension that is not an insured pension offered by an insurance company. SIPPS generally offer access to more different kinds of assets such as individual shares, ETFs, commercial property and more besides.
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