Making The Most out of your ISA and SIPP
How to leverage the power of Savings Accounts
Hello everyone and welcome back to my investing series! These articles are aimed at explaining the many benefits of investing as well as providing you with a general idea of how things work in the world of finance. I’m trying to keep everything as beginner-friendly as possible so that even people who’ve never thought about investing can have an idea of where to start, but there might be some interesting bits that seasoned veterans can benefit from as well! In today’s installment, we’ll be talking about the importance of Savings Accounts and how to get the most out of your ISA and SIPP. If you’re still wondering whether you should dive into investing, then have a look at the last article I posted which is all about understanding the importance of investing in your future.
My experience with SIPP, ISA and Passive Investment
My experience has led me to believe that passive investment is most suitable for SIPP and ISA. Leveraging SIPP and ISAs has allowed me to start safely investing without exposing myself to any big risks. In my opinion, this makes them the best option for beginners – you don’t have to spend a lot of time (and money) on analysing financial statements and consulting with various advisors. From there, you can diversify and branch out with different funds.
If you don’t want to start off all on your own (if you lack the time to learn, for example), you can always get in touch with a financial advisor. An experienced advisor will take most of the load off your shoulders and point you in the right direction. I’ve had the pleasure of working with quite a few advisors and let me tell you – the good ones can really make investing a breeze! Do keep in mind, however, that professional financial advisors come with a fee.
SIPP and ISA
What is a SIPP?
A Self-Invested Personal Pension – or SIPP – is a way to build your own pension pot to prepare for retirement. It is a great option for those who want more control over their pension, as you decide how much money you invest and where you invest.
You can run a SIPP alongside an existing pension so is also suitable for those who are paying into a company pension.
And just like a company pension, with a SIPP you will receive tax relief on your investment. This means for basic rate taxpayers, for every £100 paid into the pension, the government reimburses you £20.
For some readers of this piece, retirement may feel a lifetime away; especially when more immediate financial concerns – saving for university, a home of your own, a wedding and children – are taking up all your time and energy.
But, the sooner you begin to prepare for retirement the better. The more money you put in, over the longest amount of time, the bigger your pension pot, so start investing in your retirement now.
What is an ISA?
An Individual Savings Account – or ISA – provides a tax-free way to save.
You can save up to £20,000 each tax year in an ISA. There are various types of ISA and you can split the maximum £20,000 savings across any of them.
It is important to note here that an ISA is not the same as a SIPP. As a pension, you cannot withdraw from a SIPP until you’re 55, whereas with an ISA you can withdraw your money whenever you need it.
How many ISAs can I have?
The answer depends on understanding the different types of ISA. Remember – this isn’t a set-in-stone recommendation! If you need financial advice, tailored to your specific circumstances, I’d suggest that you seek an independent financial advisor!
ISA – Individual Savings Accounts
The purpose of ISAs is to help you stay on top of taxes. If you buy something and it goes up in value, that’s called a capital gain. You have to pay tax on that.
One of the beautiful benefits of owning stocks is that you get a dividend income – as a partial owner of a company, a fraction of its income comes back to you in the form of a dividend. Again, however, the tax issue comes up – you need to pay a certain amount of this money back – in tax!
And here’s what makes ISA amazing – you don’t pay tax on it! You don’t pay tax on capital gain and you don’t pay tax on dividend income. And even if your investments don’t happen to be in an ISA, you still gain dividend allowance!
For the 2018-2019 tax year, that adds up to £2000! And above that allowance, you will need to pay some kind of tax, ranging from 7.5% for the basic rate up to 38.1% for the additional rate. Perhaps a good way of thinking about your ISA is an invisibility cloak. Any cash that is inside the invisibility cloak will be invisible to the taxman! It’s completely outside of the tax system.
So, now let’s think about a single tax year – how many ISAs can you have?
Your ISA allowance in 2018-2019 is £20 000. And you can split that between the various types of ISA. Let’s have a look at a few examples (remember – this isn’t a recommendation!)
- You could put £12 200 in Vanguard Stocks & Shares ISA
- £3000 can go into a Nationwide Cash ISA
- Yet another £3000 can be put in a Ratesetter Innovative Finance ISA – (if you’re interested in Peer-2-peer lending that is)
- Then, you can invest £5 000 in an Orbis Junior ISA (for children)
- The remaining £1000 can go into a Nutmeg lifetime ISA
And so, we come to the conclusion that you can use up to 5 ISAs in a tax year. Additionally, if you have children, they can also have ISAs!
How many types of ISA are there?
There are currently five types of Individual Savings Accounts in the UK:
- Cash ISA
- Stocks and Shares ISA
- Innovative Finance ISA
- Help to buy ISA
- Lifetime ISA
The Five Types of ISA #1 – Cash ISA
A Cash ISA is essentially a deposit account in a bank. Very safe and reliable, this type of ISA provides you with low-risk investment opportunities. But remember – as with all other types of investing, the general rule of risk-returns also applies. The lower the risk, the lower the returns.
The beauty of cash, however, is that it doesn’t crash! Unlike stock markets that tend to crash once every decade or so, the money that you put towards a cash ISA will be there to stay! So, your expectations should be set relatively low – you can’t expect a magical even to boost up your ROI. If you’re working with a 2% interest, for example, your £1000 pounds would grow from 1000 to 1060. Not that amazing, you might say. Yes, but it’s safe! The number one enemy of investment, the threat to investors all over the world is inflation. And, in the UK, that tends to hover at around 2%. This means that, in reality, this 2% interest rate would earn you absolutely nothing. The real return would’ve been zero. Cash ISAs operate like a savings account where the interest earned is never taxed. They provide you with easy and flexible access to your money – instant access, fixed-rate access and regular savers options.
The Five Types of ISA #2 – Stocks and Shares ISA
Stocks and shares ISA is an ISA you can use an ISA to invest in bonds and shares. Usually managed by a dedicated (human) service provider, these usually come with various management fees.
A tad riskier than the “cash” option, this type of ISA has the potential of netting you a much better return on your investment. The name, however, can be a tad misleading – the qualify investments are rather broad. Stocks and Shares ISAs encompass:
- Stocks (obviously)
- Governmental Bonds
- Corporate Bonds
- Exchange Traded Funds
- Unit and Investment Trusts
- OEICS and UCITS
The Five Types of ISA #3 – Help to Buy ISA
A Help to Buy ISA is the perfect fit for first-time buyers. The government adds 25% (capped at £3,000) on top of your savings when you use them to buy your first home.
The Five Types of ISA #4 – Innovative Finance ISA
Innovative Finance ISAs are excellent for investing in other business, crowdfunding or properties, this type of ISAs won’t tax the interest gained from lending money.
If you happen to be interested in Peer-to-peer lending, this is the ISA that you’ve probably gravitated towards first. These types of ISAs allow you to lend funds directly to other people, without having to rely on banks as intermediaries. Some crowdfunding ISAs also offer Innovative Finance ISAs. Here are a few projects to take into consideration:
Again, I’d like to remind you that this isn’t meant to be set-in-stone rules. I am by no means affiliated with these projects and they’re merely being listed here due to their popularity. If you happen to be interested in this type of investment, I’d urge you to look them up online, do your own research and assess the pros and cons of each of them for yourself.
Remember, however, that this is an untested market and the probability of problems arising is pretty high.
The Five Types of ISA #5 – Lifetime ISA
A lifetime ISA serves a dual purpose. One of these purposes is to save money and buy a house. The beauty of this ISA is that the government gives you a 25% bonus towards your savings. Although you can only put in £4000 each year. It can go into cash or stocks and shares. But, be careful – there are steep penalties included if you happen to withdraw your money unless you’re buying a house or retiring. There’s the 5th one
Once again, I would like to recommend that you do your own research before putting any money towards specific savings or investment accounts! As all of my other articles, this blog post is entirely based upon my personal experience and should not be taken as investing advice. If you’re unsure of which option is the best for your specific case, you might also want to consult with a certified financial advisor – they will be able to guide you through the process step-by-step and ensure that you steer clear of any mistakes.
And what about you – have you tried your hand at investing before? Which type of ISA do you prefer and why? As always, if you have any questions, or if you think that I’ve missed something crucial, do not hesitate to drop me a line in the comments below – I love hearing from you!
I have included links to useful resources below, but in every case, it is important to seek professional advice on your finances to ensure you are making the most informed and suitable choice for you.
Websites and communities
- Stockopedia Main Website
- Elizabeth’s contact details
- Hargreaves Lansdown
- ANN WILLIAMS – The Wealth Chef (an excellent source of free videos and practical financial information, backed up by a stellar community)
- ISA calculator (UK-only)
- The MELO conference website (I attend the conference twice per year and I’ve learned a ton!)
Other Savings Calculators:
- Monevator Article: How to choose an online broker
- Monevator Article: Examples – Lazy Passive Investments
- Monevator Article: What is an Index Tracker
- Monevator – Retirement Plan How-To
- CNBC – Warren Buffet on Index Funds
- Money Saving Expert, Full ISA Guide
More from Warren Buffett:
Additional Books & Audiobooks that I recommend:
- Audio books on Audible – use Audible to listen to the books, if you don’t have time to read.
- Tony Robbins – MONEY Master the Game
- Tony Robbins – Unshakeable: Your Financial Freedom
- Unshakeable: Your Guide to Financial Freedom
- Benjamin Graham – The Intelligent Investor
- David Chilton – The Wealthy Barber
- Robert Kiyosaki – Rich Dad Poor Dad
YouTube Channels and Videos