Retirement is a topic that I think about daily. It’s not that I don’t enjoy working, I do, it’s that I want to have the freedom to choose when I work. Today, I’m tied to my job, I have to work, pay for life, my children, and my financial future.
If I keep saving, investing, and building wealth over the next ten to fifteen years, hopefully, there will be a time when I can be wealthy enough to choose whether I want to work. This brings the question, how the best way to save money in the UK? Where do you put it to grow safely and securely over time?
What is an ISA?
It’s said in life there are two certainties, death and taxes. In the UK, it’s possible to save, invest and let your money grow tax-free through an Individual Savings Accounts (ISAs). An ISA is a scheme with which a UK resident can pay into a saving plan to a limit of £20,000 each year and have that money grow tax-free over time. If you want to open an ISA in the UK, you must be;
- 16 or over for a cash ISA
- 18 or over for a stocks and shares or innovative finance ISA
- 18 or over but under 40 for a Lifetime ISA
- A UK resident or a Crown Servant
ISA Saving Limit?
The figure for ISA allowance changes every tax year. The announced figure is £20,000 for the tax year of 2021/22. You can either put £20,000 in a single investment or make a portfolio of investment.
Remember, the current limit is £20,000, meaning that you need to pay £20,000 between April 6th and April 5th the following year. What you cannot do is join ISA’s together. You cannot, for example, pay in £10,000 this, and £30,000 next year.
Types of ISA’s?
There are five different types of ISA’s in the UK each with there own advantages and drawbacks. Before you start investing into an ISA, you need to analyze what works best for you when you take into account your needs and your financial future.
Remember, while you can only invest £20,000 per year into an ISA, its £20,000 per person over the aged of 17. For a couple this means you have an allowance of £40,000 per year. The five ISA categories are the following:
- Cash ISA
- Stocks and Shares ISA
- Lifetime ISAs
- Innovative Finance ISA
- Junior ISAs
It’s worth noting, you can also invest in different categories at the same time. As an example, you could invest £10,000 into a cash ISA, and £10,000 into a stocks and shares ISA, but you cannot total more than £20,000 per person in the UK
A cash ISA is the best option if you want to invest money but shy away from risk. This type of ISA is risk-free, and you get to invest at the age of 16. A cash ISA is effectively a tax free savings account where you save money, receive interest and pay no tax on the growth.
The problem, the interest rate is really poor given interest rates are slow. As an example, The Scottish Building Society currently pays an interest rate of 0.7% on amounts of £100 or more. If you saved £5,000 this year, you’d receive £35 in interest. While it’s possible to get a slightly better rate if you lock in your cash for a set period of time, the rates are still not very attractive. A five year fixed term period with Coventry Building Society would only pay out 1.75% or £175 per year with the same £5,000 as above.
Whether you lock your cash in for a long or a short period depends on what you believe will happen to interest rates. As it stands today, rates offered on fixed-rate ISAs have been steadily creeping up over the last few months. In addition to this, the Bank of England has announced an increase of the UK base interest rate from 0.1% to 0.25%, meaning this could plausibly continue.
If you think rates will increase and you may want to fix for a shorter period of time. That way, if rates do rise, you wont be locked at a lower rate for too long. However, if you think rates could fall, fixed-rate accounts offer some protection.
Stocks and Shares ISA
The next type of ISA is Stocks and Shares. With this type of ISA, you can invest your money into the stockmarket, typically through an online platform, where you can buy a range of asset from shares, to funds and REITs.
While there is some risk involved in investing on the stockmarket and you should be focusing on a timeline of five years at a minimum, if you do make a profit on your investment, you will not pay a penny on tax.
Investing your spare money is important. If you saved £200 per month, from the age of 23 to 68, (2049 is the year when I can retire and benefit from my state pension), you’d have a pension pot of £110,400. If you invested it, and it grew by a conservative 8% a year, you would have over a million pounds in your pension pot – £1,044,391 to be precise.
In the UK you have a selection of options to set up an ISA, my favourite is with Hargreaves Lansdown who are a leading savings and investment platform based in the UK. They have built up a good reputation for their 1.2 million clients and currently look after over £100 Billion in savings and investments.
The HL.co.uk ISA is my favourite way to invest money. The ISA cost’s just 0.45% each year, while allowing you to access over 2,500 funds, shares and investment trusts, or access one of six pre-built funds through the H&L platform. If you’re buying into funds, there is no dealing charge.
Lifetime ISAs are best for people planning for their retirement. The key point is that they are designed to be used later in life, and therefore, any monies you put into your Lifetime ISA cannot be accessed until you are 60 years old, are buying your first home, or are terminally ill with less than 12 months to live.
Typically there are two kinds of Lifetime ISAs:
Stocks & shares Lifetime ISA: The risk and return terms are same as it was for Stocks & Shares ISA with few more disadvantages. You can lower the risk by making a long-term investment. The allowance for this type of ISA is £4,000, but the benefit is the government adds a bonus of 25 % on the money you could save.
Let’s say, you could save £3000 in one year and the state gives you a bonus on it. After adding the bonus your saved amount would be £3750. It allows you to withdraw money after reaching 60 or in the process of purchasing your first home. An individual within the age range of 18 to 39 can open this account.
Cash Lifetime ISAs: If your goal is to save for your first home then this might be your type of investment. You know when you want to buy the house and the amount of your savings. And all the money you made from it is tax-free.
Innovative Finance ISA
An innovative finance Isa (IFISA) is slightly different type of ISA given how it works. The idea is that rather you investing into stock’s and shares, you lend through a peer-to-peer lending platform. Peer-to-peer lending platforms such Crowd2fund.com, match up investors, who are willing to lend, with borrowers that are looking to borrow for their business.
The idea behind this type of investment is that you’re cutting out the banks by investing through an online platform and thus the charges a less, and your interest is greater. Its not uncommon to find balance portfolio’s of peer-to-peer debt paying up to 10% per year, tax free.
The downside, is that it’s more of a risk given your money is not protected. Over the last few years several platforms have collapsed or been bought by other companies, and therefore its a good idea to only invest into established companies who allow a diversified portfolio and have protections in place should they run into financial difficulties.
Its also a good idea to understand the financial’s and charges involved. What annual fee does the platform charge, and any charges it imposes, if you want to withdraw cash early.
Junior ISA’s are a great way to save money for your children’s financial future. As part of your allowances, you can save £9,000 per year into either a Junior Cash ISA, or a Junior Stock’s and Shares ISA.
The idea for a Junior ISA is that you save money either monthly or yearly, and the money grows, tax-free over time to be used for your children once they’re 18 years old. While you can open a Junior ISA at any stage between the age of 0 and 17, the money cannot be used before the child reaches 18, even though the account’s control transfers to them at 16.
Interest rates depend on how your money is invested. With a cash ISA, the best rate we could find is at the Family Building Society who pays a top rate of 2.4% on £3,000 or more. If you’re invested in a stock’s and shares ISA, your rate of return depends on your portfolio growth and what you’re invested in.
How Safe Are ISA’s
ISA’s are generally considered safe forms of investments as they work in the same way as a regular bank account. As a result, any monies that are in a UK-regulated bank or building society account are protected under the Financial Services Compensation Scheme up to £85,000. In the unlikely event that a UK Bank or Building Society fall into financial difficulties, the first £85,000 is guaranteed by the Financial Services Compensation Scheme.
If you have more than £85,000 of savings (including cash ISAs and others) in one bank, then, in the unlikely event it went bust, only the first £85,000 is fully guaranteed. So for total peace of mind, don’t put more than this in any one bank or Financial Institution. Its a good idea to spread your savings across multiple banks and financial institutions.
ISA’s are a great form of investment given the tax free aspect. My personal ISA has over £100,000 inside and last year increase by over 20%. That’s a great £20,000 that I don’t have to pay tax on.
While I personally only use Stocks and Shares ISA’s, Cash ISA’s are transferable from one provider to another. So if you are not satisfied you can always take your ISAs to other providers. Although there is no system for opening a joint ISA you can choose your beneficiary. So, after your death, your significant other takes over your ISA.