When it comes to investing there are various accounts, sometimes called tax wrappers, that you can choose from. But for most ordinary investors, there are only two that matter – a pension and an ISA.
ISAs
The only ISA that most of us need is a Stocks and Shares ISA. That’s for long term savings at least. If you’re investing towards a house deposit one day, then you should definitely consider a Lifetime ISA.
This is where the government adds 20% to whatever you put in to help you build a house deposit. The downside of those accounts is that you have to use it for a deposit on your first house, OR you can leave it in there until age 60 and use it for retirement purposes.
The annual allowance into an ISA is £20,000. This means that you can contribute £20,000 into your ISA accounts in any one tax year. You can spread this amount across your different ISA accounts.
For example, the maximum you can put into a Lifetime ISA is £4,000 per year. That means you can put in up to £16,000 into another ISA. You can only pay into one of each type of ISA in any tax year. So you can’t split your £20,000 between two Stocks & Shares ISAs, for example.
Cash ISAs are also available, but for the reasons we’ve just gone over in point one, Cash is NOT an investment. Only use a cash ISA or a Cash Lifetime ISA if your savings term is shorter than three years or so.
ISAs are completely tax free, which is a cool benefit. You pay no tax as the money grows inside the account, and no tax when you take it out. Usually there are no restrictions as to what you can take out and when, so they are a very flexible account. Some providers even offer Flexible ISAs, where if you take out an amount during the year and replace it within the same tax year, that doesn’t affect your allowance.
So, let’s say you have £20,000 in an ISA and you take out £5,000 for some purpose. Then later on that tax year you can pay in £25,000. £5,000 is the money you took out earlier, and the other £20,000 is your allowance for the year.
Pensions
The other account that matters is a pension. Pensions are often considered to be complex beasts, and in some ways they are. Broadly speaking, pensions are divided into occupational plans -those provided by your employer, and personal plans.
Taking occupational schemes first, these come in two flavours. Defined Benefit, where you’ll end up with a guaranteed income one day based on your salary while working, and the length of time you have worked for your employer.
The other type is Defined Contribution, where you and your employer contribute into a pot, and what you get at the end is unknown – it depends on how much you put in and how the money grows and a few other variables besides.
Defined Benefit plans are in decline. They tend now to be the preserve of public sector employers like the NHS and civil service. If you have one, they are extremely valuable. Personal plans are always defined contribution – it’s up to you to put in as much as possible to get the maximum benefit at the end.
Pension plans attract tax relief. In simple terms that means the government gives you some of your tax back to incentivise you to pay into a pension, which is a very useful benefit. While money is inside a pension plan, it grows tax free, but there is some taxation when you take the money out. You can’t touch money in a pension, under current rules, until age 55, and that age is rising.
After 2028, it will rise to your state pension age minus ten years. Pension funds and ISAs are merely accounts. They are mechanisms for investing money for your future. What really matters though is what’s inside them.
Leave a Reply