ISA, LISA, or pension?

ISA, LISA, or pension?

 

In 2017, the government launched the Lifetime Individual Savings Account (LISA).

There are now three major savings vehicles for consumers to choose from – the Individual Savings Account (ISA), the standard pension, and the LISA.

What do you need to know about all three? The Smart Team summarises…

 

Individual Savings Account

With an ISA, you can save or invest money and any income or interest you make from those savings or investments will be made free of tax.

The ISA runs in parallel to the standard accounting year – April 6th to April 5th. Once April 6th comes around, your allowance begins again. At time of writing, the allowance per person per year for an ISA is £20,000.

In any given year, you can invest in up to three different types of ISA – a cash ISA, a stocks and shares ISA, or an innovative finance ISA.

SMART TEAM tip – there are two additional types of ISA (the junior ISA and the help to buy ISA (designed for wannabee first time property buyers)) but, for the purposes of clarity, we’re not covering them in this piece.

A cash ISA is very similar to a normal savings account you’d receive from a bank or building society, the only different being that you do not have to pay tax on that interest.

A stocks and shares ISA (sometimes called an investment ISA) is a savings account made up of shares in quoted companies (i.e. listed on a recognised stock market), unit trust, government gilts, corporate bonds, investment trusts, and open-ended investment companies.

The advantages offered by a stocks and shares ISA is protection from two different types of tax – dividend tax and capital gains tax.

You won’t pay tax on any dividends you receive from your investment nor pay any capital gains tax when you “crystallise” the value of your investments – that means, selling them. You still retain your £5,000 dividend allowance (going down to £2,000 in 2018/2019) and your capital gains tax allowance of £11,300 a year (rising to £11,700 in 2018/2019).

If you choose to invest into interest-bearing vehicles (like gilts and bonds), you will not pay tax on the interest (saving 20% for a basic tax rate payer, 40% for a higher rate taxpayer, and 45% for an additional rate tax payer).

SMART TEAM tip – the value of your investments in a stocks and shares ISA can go down as well as up. It is a riskier investment than a cash ISA.

An innovative finance ISA allows you to put your savings into peer-to-peer lenders like Funding Circle or Zopa. Interest you receive on top of the principal of the loans made on these platforms are not taxed.

Generally, on more established platforms, your money *should* be safe however peer-to-peer lenders have run into trouble before.

 

Pensions

As long as they have not withdrawn money from their pension pot after the age of 55, a UK tax payer can increase the size of their pension by £40,000 each year subject to a lifetime limit of £1,000,000 (at time of writing).

For most pension schemes run by companies (including auto enrolment pensions), both you and your employer will pay money into your pension pot.

Every contribution made to your pension and any returns you enjoy from your pension are both tax free.

 

LISAs

LISAs are designed for one of two purposes – for the saver to invest in their retirement or to buy a home.

LISAs can be opened by anyone aged between 18 and 40. There is currently no innovative finance LISA available but cash LISAs and stocks and shares/investment LISAs are available.

You currently have a £20,000 a year limit that you can use to save into ISAs. You can allocate up to £4,000 of that £20,000 to invest in a LISA, subject to a lifetime maximum of £128,000 (before bonus payments).

For every £1 you put into your LISA, the Government will contribute 25p. Therefore, an investment of £4,000 a year would be added to by a £1,000 contribution from the government. Your first bonus is paid when the first year finishes – after that, the bonus is paid every month meaning that you can now benefit from monthly interest/earnings compounding.

As soon as you reach 50 years old, you won’t be able to pay into your LISA anymore and you will not receive any government top-up. You can take out money from your LISA once you’ve passed 60 years old and you won’t have to pay tax on any withdrawal.

 

SMART TEAM thoughts

SMART TEAM welcomes the introduction of LISAs – anything to get Britain saving is a good thing, as far as we’re concerned.

But how do LISAs stack up in comparison to ISAs and pensions?

ISAs and LISAs consist of money that you’ve earned but have already paid tax on (or will pay tax on if you complete a Self Assessment). With pensions, you receive tax relief on every contribution made (up to the annual and lifetime limits).

With ISAs and LISAs, you are the only person paying money into it. With a pension, your employer will make an additional contribution.

Pensions are also very generous in comparison to ISAs and LISAs. To add £1,000 to your pension pot, a higher rate tax payer (and his/her employer) need to put in just £600. For basic rate tax payers, that’s £800 and for additional rate payers, it’s £550.

If you’re self-employed and a higher rate tax payer, you will get more from a pension because the tax relief is larger than the LISA bonus. However, please consult us if you’re self-employed because the picture is never entirely straight forward.

If you are shareholding company director and you’re at your annual or lifetime limits, an ISA or LISA could be a better option than paying more into your pension pot because the contributions you make would be much more heavily taxed than below the limits.

 

Want our help?

If you want to speak with one of our team about the new LISAs or about savings and pensions in general, please call 01202 577 500 or email info@yoursmartteam.co.uk  for any help and advice you may need.

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