Investing for retirement is a necessary step and must be an efficient one. Just stashing some cash away may not turn out to be an effective method to save for retirement. The cash neither grows on its own nor provides tax benefits like other modes of investing and saving. Therefore, it is advisable to choose the right investment account to save for retirement.
However, moving from cash to the UK capital market requires a lot of knowledge, patience, and judicious decision making. The exercise can turn out to be very stressful and includes choosing the suitable platform and account manager, meeting your specific requirements. In this article, we will provide you with in-depth information about the different types of investment accounts, like SIPP, ISA, and GIA, to choose from.
Starting Your Savings Journey
The objective of saving for retirement is to ensure that you save enough money that lasts for your entire life post-retirement, the savings offer tax benefits and interest income, and savings are flexible and liquid.
Most of the individuals in the UK begin their savings journey with the annual ISA. The Individual Savings Accounts or ISAs are highly flexible and liquid and are used to save money for a rainy day. They also provide much sought-for tax relief to the UK taxpayers. However, the contributions to ISAs are capped at an annual allowance of £20,000. Any investment in ISAs beyond the annual allowance becomes taxable.
Usually, after the individuals reach the upper limit of investing in ISAs, they move to SIPPs. SIPP has a higher annual allowance of £40,000 and better tax benefits; however, it lags in terms of liquidity and ease of access when in need. The next logical step in your savings journey is to transit to GIAs or General Investment Accounts. They are not capped by annual allowance limits as they do not offer any tax relief benefits; however, they are quite flexible and allow you to contribute or withdraw as much money as you like, whenever you like.
Therefore, it is critical to analyze the relative attractions, strengths, and drawbacks of ISA, SIPP, and GIA to choose one among them or to spread the savings among them.
Individual Savings Account (ISA)
ISA is an individual savings account that allows the UK taxpayers to invest their money either in cash, shares, or innovative financial products. You can choose to invest in either of the ISAs based on your risk appetite and portfolio diversification objectives. Any investment made in the ISAs is tax-free up to the maximum limit of £20,000, beyond which the contribution does not attract tax relief. The eligible UK residents also have an option of Lifetime ISA in which they contribute £4,000 per year until they are 50 years of age, and the government adds a 25% bonus to the savings every year, to a maximum of £1,000 per year. Additionally, Junior ISAs are also available to save efficiently for children.
Annual Allowance: The annual allowance for ISA is £20,000, and the contributions can be made towards cash, stocks, commodities ETF, Lifetime ISA, or a combination thereof. Any contribution beyond the annual allowance is subject to income tax, and the unused annual allowance does not roll over to the next tax year, unlike SIPP annual allowance.
Flexibility: ISAs are flexible, and you can contribute or withdraw money at any time, without losing the tax benefits. The flexible ISAs also allow you to withdraw money when needed and then put it back the same tax year without affecting the allowance for the current year. However, the rules and regulations vary from one ISA to the other and need to be checked before making the investments.
Tax Relief Forms: As discussed, the contributions made towards ISA are tax-free up to the annual allowance of £20,000. However, the money generated by making investments from the ISA is exempted from the capital gains tax, income tax, and dividend tax.
Self-Invested Personal Pension (SIPP)
SIPP is a tax-efficient personal pension scheme that allows individuals to save a part of their pre-retirement income for use after retirement. SIPP offers the flexibility to invest in a variety of asset types, including bonds, equities, real estate, and commodities and adds the required diversification to the post-retirement portfolio.
Annual Allowance: Similar to ISA, SIPP also has an upper limit of savings that can be made for tax benefits. SIPP is subject to an annual allowance of £40,000 or 100% of the total annual salary, whichever is lower. For individuals with income more than £150,000 per year, the annual allowance goes down by £1 for every £2 of the excess income. The annual allowance of ISA does not roll over to the next year; however, the annual allowance of SIPP can be carried forward from the past three tax years and is subject to a maximum limit of £1.05 million, called Lifetime Allowance.
Flexibility: The withdrawals from SIPP are not as easy and flexible as those from ISA. The contributions to SIPP get locked-up till the age of 55, and any withdrawal before the designated age attracts a 55% to 70% tax bill.
Tax Relief Forms: SIPP is an excellent investment avenue for tax savings. Any saving in SIPP, up to the annual allowance limit, receives tax relief, in addition to no capital gains tax, dividend tax, and income tax on money earned on the investments made from the SIPP account. Overall, SIPP offers a 20% tax relief to the basic rate taxpayers, and the relief increases to 40%-45% for higher taxpayers. Additionally, the lump-sum withdrawal of 25% of the funds is tax-free at the age of 55, while the remaining 75% is subject to income tax.
General Investment Account (GIA)
GIA is a flexible mode of saving without offering any tax benefits. When the individuals have exhausted their upper limits of investment in ISA and SIPP, they can make contributions to GIA, with no limit or restrictions on deposits and withdrawals.
Annual Allowance: There is no upper limit to contributions made towards GIA. However, capital gains on investments made through GIA are tax-exempted only until the limit of £12,300. Any capital tax gains above the allowance limit are taxable at the rate of 18% for the basic taxpayers and 28% for higher taxpayers.
Flexibility: GIA is equally flexible as ISA as the withdrawals and contributions can be made at any time. GIA contributions and withdrawals are not subject to age restrictions and offer a lot of flexibility and liquidity.
Tax Relief Forms: Since GIA is not a government-funded tax wrapper, it does not provide any tax benefits like ISA or SIPP. Income from investments made through GIA, including any capital gains or dividends, is subject to tax and is not eligible for rebates.
Thus, with a wide variety of choices, the decision to choose the right savings account for you depends on your financial objectives and goals. For those looking for more flexibility and liquidity for unforeseen circumstances, ISA and GIA could be better options as compared to SIPP, while for those saving for retirement and looking for higher tax relief will find SIPP a better alternative.