Article by Yoram Lustig
In a series of three short articles, we explore three ways to save and invest for retirement, starting with Individual Savings Accounts (ISAs).
Individual Saving Accounts (ISAs)
ISAs are tax-efficient accounts that adult UK residents can open with most high-street banks or building societies (Google ISA to find plenty of information online). You can put up to £15,240 in ISAs in 2015/16 tax year, splitting your money however you wish between cash ISA or stocks and shares ISA (we will ignore other types of ISAs).
Cash ISA is a savings deposit, earning interest on your money, without taking investment risk. Stocks and shares ISA allows you to invest in funds (pooled vehicles whose manager invests in securities) or individual bonds and stocks. Investing is riskier than saving, so you can lose money. However, investing’s potential returns are usually higher than those on savings. High returns require risk.
Whether you save or invest depends on your financial goals and risk tolerance. Over the long term, by investing prudently through diversifying your portfolio, minimising charges and sticking with a long-term plan, extra returns can add up. However, do your homework before investing.
As long as your money is in ISAs, you pay no taxes on interest on savings or gains on investing. This is a valuable benefit. Saving 20% or more on taxes can accumulate to a significant amount over the years. Unlike pensions, where you pay no income tax on money you put in, but pay tax when taking it out, with ISAs you pay income tax on the money you put in, but pay no tax when taking it out.
ISA’s are flexible
ISAs are flexible. You can withdraw your money whenever you want. Flexibility is important since you can never know how your circumstances or regulations change. It is advisable to have some cash you can quickly access. Pensions, on the other hand, lock your money until you retire, usually from the age 55 onwards.
In 2016 the Government introduced a personal savings allowance (PSA). Depending on your income, you can earn up to £1,000 interest in deposits a year tax-free. This could be better than cash ISA since interest rates may be higher. However, you lose your annual ISA allowance if you do not use it and you can switch from cash to stocks and shares ISA when you decide to invest instead of save, while keeping the ISA’s tax shelter. And the Government can cancel PSA one day. Think carefully before giving up on cash ISA.
When choosing ISAs, shop around. Different providers offer different interest rates and investment options. If you are unhappy with your ISA, you can transfer it. Consider, however, any penalties involved in withdrawing from fixed rate ISAs before the notice term ends, as well as time outside the market when switching between stocks and shares ISAs.
ISAs are a simple, flexible account, shielding your money from taxes. Use them alongside other saving and investing vehicles, aiming to diversify complementary sources of retirement income and maintain flexibility in your retirement planning.
Part 2: Self invested personal pensions
Part 3: Residential Property
Yoram Lustig is the author of the new Financial Times Guide: Saving and Investing for Retirement. It is out now, priced £26.99 from FT Publishing, and available from Amazon