Choosing to step out of cash and into capital markets can be a daunting decision in itself. You will then have to decide how involved you want to be with any investment decisions, which investment manager or platform you would like to use, and finally, you have to decide which type of investment portfolio to open; ISA (Individual Savings Account), SIPP (Self-Invested Personal Pension) or GIA (General investment account)? We explain the main features of each product to enable you to make an informed decision.
In general, most begin by filling their annual ISA allowance as this product allows for both flexibility and tax relief. The ISA annual allowance has risen considerably over the past few years and is also a lot more flexible than it was. The annual allowance for the current tax year (2017/18) is £20,000, but in 2010/11 it was just £10,200. Investors used only to be able to save 50% of their allowance in a cash ISA, but these restrictions have since been lifted.
If you have a few years of filling your annual ISA allowance behind you, you shouldn’t have too many liquidity concerns. So once you have reached the £20,000 ISA limit, it might be time to start filling the other government-funded tax wrapper, the SIPP. The reason that this comes second on the tax-wrapper list is because of its poor liquidity. Funds that you contribute to your SIPP cannot be accessed (without incurring a large tax bill) until you are 55. However, this lack of liquidity does not rule the product out. It offers fantastic tax relief on contributions and has a much higher annual allowance than the ISA, meaning that if you don’t need the liquidity, then the SIPP moves into first choice.
If both of these allowances are full, it’s time to invest in your GIA and take advantage of your capital gains allowance (currently £11,300). The GIA doesn’t offer any tax relief but it is flexible and has no restrictions on the annual allowance.
The rolling British countryside and beautiful London architecture are just two of the benefits of being a UK resident. The ISA may not be third on the list for everyone, but it is undeniably another great perk of the UK residency status. Introduced in 1999, the ISA offers tax exemption on cash or stocks & shares accounts and provides the UK population with annual tax relief of around £2.6 billion.1
Source: HM Revenue & Customs
The product is a widely used savings tool throughout the UK. Data recently released shows that around 2.6 million stocks & shares ISA accounts were subscribed to in 2016/17, a marginal increase on the previous tax year.2 The market value of stocks & shares ISA holdings at the end of 2016/17 stood at £315 billion which represents a 20% increase compared with the value at the end of 2015/16.
An ISA is a government-funded tax wrapper. It comes in two main forms: the stocks & shares ISA and the cash ISA. The other forms include the Lifetime ISA (LISA) and Innovative Finance ISA, these accounts are less frequently used. Although known as the stocks & shares ISA, this type of account would be better suited to the name ‘investment ISA’ as the account holder is not restricted to just stocks & shares. For example, the investor could hold bonds or a commodities ETF. Any money that you put into either type of ISA will not be liable to income tax, dividend tax or capital gains tax. However, these contributions will have already been subject to income tax and this tax is not subject to relief under the current ISA rules.
For example, were you to open a stocks & shares ISA, you wouldn’t pay any income tax on the interest on the bonds within the ISA – you would keep the full amount. No dividend tax would be payable on any dividend income within an ISA, whereas outside an ISA, this income could be subject to up to 38.1% dividend tax. The absence of capital gains tax makes a big difference too. Were those assets held outside of an ISA, any profits made above the annual personal allowance (currently £11,300), would be subject to tax at either 18% or 28%. As you can imagine, these tax savings really do add up.
There is an annual limit on the amount that you can save in this valuable tax wrapper. The ISA timetable runs in line with the tax year – so try and save up to your full ISA limit before 5th April. Any unused allowance does not roll over into the next tax year, so if you don’t use it, you lose it. At the moment, the annual allowance is £20,000 (2017/18). You can put the full amount in a stocks & shares ISA, the full amount in cash or divide the sum between the two. If you have any other type of ISA account, you could split the annual allowance between all of them (although do be aware of the annual limit on the Help to Buy ISA and the LISA). You don’t have to use the same provider for your cash ISA, or other types of ISA accounts you may have. You can open as many different stocks & shares ISA account as you wish, but you can only pay into one account during each tax year.
Flexibility is another great benefit of the ISA. There is no lock-in period so you can access your money whenever you want. This liquidity is invaluable if you are saving for a life event (for example, buying a house, children’s education). Over the years, a lot of investors tend to open different ISA accounts with different providers. The flexibility of the ISA means that you can easily transfer ISAs from one provider to another to bundle all of your accounts in one place. Many of our clients transfer their various ISAs to us in order to reduce complexity.
UK pensions have changed considerably over the past 50 years. In the past, retirees may have been able to rely on a defined benefit workplace pension throughout their retirement, but younger generations won’t have the same opportunity. It is sensible for those generations to take precautions and save for their own retirements. A SIPP is a tax-efficient way of doing so.
This tax wrapper allows individuals to make their own investment decisions or – despite the words “self-invested” in its name – to outsource them to an investment manager. Similar to other personal pensions, you receive tax rebates on any money you put into your SIPP, in exchange for restrictions on when that money can be withdrawn.
Tax relief is the great benefit of the SIPP. As discussed earlier, ISAs offer tax-free saving but any contributions will have been subjected to income tax. This is income tax that you won’t get back. But when it comes to SIPPs, you receive tax rebates on any income tax already paid.
Basic rate tax relief (20%) is automatically paid, so if you contribute £8,000, the government will top this up to reach a total contribution of £10,000 straightaway. Higher-rate and additional-rate taxpayers will have to claim back the extra income tax they paid but will eventually receive 40% tax relief and 45% tax relief on contributions, respectively.
Like an ISA, any holdings inside a SIPP can grow free of income, dividend, or capital gains tax. Add the power of compounding to these savings and the compelling function of the SIPP wrapper becomes clear. Once you have accessed your funds, you can withdraw only up to 25% tax-free and the remaining 75% will be taxed as income. Nevertheless, the SIPP remains highly attractive from a tax perspective.
There are annual and lifetime limits on the amount you can contribute to your pension. As at tax year 2017/18, the annual limit is £40,000 and any more than that will not be subject to tax relief. The lifetime limit is currently £1 million and assets over that will be subject to a tax charge of 25% if paid as pension, or 55% if taken as a lump sum.
Liquidity is important and SIPPs don’t allow the flexibility that many want. Those keen to crystallise their SIPP before the age of 55 will find themselves with a 55% tax bill on the amount accessed. If you do not inform HMRC that you have done so, a penalty could increase the tax bill to 70 percent of the amount you have accessed. Anyone needing more immediate access to funds won’t incur any tax bills when withdrawing from their ISA.
Past performance or future projections are not indicative of future performance. The assumed annual rate of growth is 6.5% which is based on the historical performance of the ARC £ Steady Growth Private Client Index from January 2004 to March 2017.
The charts show the long-term impact of saving in an ISA or a SIPP. Two savers with two different levels of income (£70,000 and £120,000) have filled their ISA allowance every year (from their net salary), or they have made the same contribution into their SIPP instead of their ISA (also from their net salary), in which case they would have received a top-up from the income tax rebate. The savers have filled their allowances every year from 2011/12 up until and including 2017/18. The higher earner is able to claim back their full personal allowance in addition to higher-rate tax relief which means that after 30 years, the value of his SIPP exceeds the value of his ISA by more than 100%, or half a million pounds. The tax relief offered by the SIPP makes a big difference to the long-term balance.
The third type of investment account is a general investment account. This isn’t a government-funded tax wrapper, but it does still offer some advantages, especially if your annual allowances are full.
As mentioned above, the GIA is not a tax wrapper so not subject to the same tax relief as allowed by ISAs and SIPPs. Contributions you make to your GIA will have already been taxed and this tax will not be subject to any rebates. You will pay tax on any gains, income, and dividends that you receive.
There is no annual limit on contributions made to your GIA as there is no government-funded tax relief. However, it is wise to be aware of your annual capital gains tax allowance, which is currently £11,300 (2017/18). Any gains you crystalise above this will be subject to capital gains tax at either 18% or 28% (depending on your tax bracket). If you do need to withdraw funds for any reason, make sure you are fully utilising your annual capital gains allowance as paying tax at 28% significantly reduces your gain.
It is unlikely that a portfolio worth less than £50,000 will generate capital gains above £11,300 in a given year. This means that any investors with GIAs worth less than £50,000 may not incur any capital gains tax if they make use of their capital gains allowance.
GIA offers the same flexibility as an ISA. There is no lock-in period which means that you can access your funds (more or less) when you want. It’s worth double checking this with whichever investment manager you choose as there are a few that do have lock-in periods.
The choice depends on your priorities. If flexibility is crucial, then an ISA or a GIA are the best for you. Maybe you are a spender and think it wise to have your money locked up until retirement? If so, a SIPP might be the right option for you.
As a general rule of thumb, we suggest starting with an ISA as that has the double benefit of tax relief and flexibility. If you are saving for an imminent life event, move on to a GIA. If you are saving for your retirement then take advantage of the great tax relief offered by a SIPP and contribute into that instead.
Sources: 1 https://www.gov.uk/government/statistics/main-tax-expenditures-and-structural-reliefs
A Stocks & Shares ISA with Scalable Capital and our GIA are protected by the Financial Services Compensation Scheme (FSCS) up to £50,000 per person, and all your securities are kept separately from our custodian bank’s assets. The bank never lends your assets to a third party or mixes them with their own assets, meaning that if either party went out of business your securities would be safe (read more about security).
Image: Unsplash.com/Evan Dennis
Risk Warning – With investment comes risk. The value of your investment can go down as well as up and you may get back less than you invest. Past performance or future projections are not indicative of future performance. We do not provide any investment, legal and/or tax advice. If this website contains information regarding capital markets, financial instruments and/or other topics relevant for investments of assets, the exclusive purpose of this information is to give general guidance on investment management services provided by members of our group. Please note our Risk Warning and the Website Terms.
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