Using ISAs to fund your retirement?
Most of you reading this will have heard of an ISA, but do you know what one is and about all of the different flavours of ISA available? This guide is aimed at giving you as much information as possible about ISAs and why/how they can be used to help fund your retirement.
This guide will give you more information about:
- The basic information on ISAs
- The different types of ISAs
- Why it may be worth considering an ISA to help with retirement planning
- ISA Millionaires!
What does ISA stand for?
ISA stands for Individual Savings Account. The ‘individual’ means that is available only to individuals so you can’t have a joint policy with your better half.
Why are ISAs so popular?
ISAs are really popular in the UK because you are not taxed on any money gained from the ISA (either through savings, dividends or capital growth). Most people will use them for short to medium term savings rather than the long term savings, however in some circumstances they can be part of a retirement strategy.
What are the ISA allowances for 2017/18?
Any adults over the age of 18 can invest £20,000 a year into any type of ISA (with the obvious exception of the Junior ISA). There are some quirky rules for 16 and 17 year olds but as they are not the target for this website, I will leave that for someone else to talk about.
If you are married you will both have £20k allowance each. Remember that money can be transferred/gifted between spouses tax free so you can use this to maximise your ISA allowances.
The £20k allowance applies to all ISAs (excluding Junior) and you can split it however you want between the following types of ISA:
- Stocks and Shares
- Innovative Finance
- Help to Buy*
*Although you could put £20k into a Help to Buy or Lifetime ISA, the maximum government bonus is capped.
What are the big advantages of ISAs?
The big advantages with ISAs are the tax savings. Every pound that grows in an ISA is tax free when you take the money out and it won’t reduce other allowances or push you into a higher tax band.
ISAs are more flexible than pensions as well. You can withdraw money from an ISA two days after opening it if you wanted. With a pension, it could be decades.
Should I be investing in an ISA rather than a pension?
For most people, a pension will be a better bet than an ISA. This is because of the tax benefits you receive now from investing in a Pension and the fact most companies will also add money into your Pension fund. However there are a number of scenarios that may make ISAs worthy of consideration:
- If you don’t pay tax at the moment (although even then you can claim Pension tax relief)
- If you want to access your money before you 55
- If you are likely to exceed the Lifetime Pensions Allowance (currently £1m)
When do you want to access the money?
If you want access to your money before 55 then an ISA is a better option than a Pension. Although you really should ensure you are not relying on State Pensions so an ISA may be useful in addition to your main Pension fund.
If you are likely to exceed the Lifetime Pensions Allowance (currently £1m)
If your pension pot is now close to a £1m, there are tax consequences so it may be worth diverting some of your income into an ISA. If you are approaching £1m or expect to reach it in the next few years before retirement, it is worth getting some advice about how it affects you personally.
The £1m Lifetime Pensions Allowance is a flexible number set by the Government and you may never reach it but it could be reduced or increased in the future. Below is the history of the Lifetime Pensions Allowance:
Tax Year – Lifetime Allowance
- 2006/07 £1,500,000
- 2007/08 £1,600,000
- 2008/09 £1,650,000
- 2009/10 £1,750,000
- 2010/11 £1,800,000
- 2011/12 £1,800,000
- 2012/13 £1,500.000
- 2013/14 £1,500.000
- 2014/15 £1,250,000
- 2015/16 £1,250,000
- 2016/17 £1,000,000
For 2018/2019 it is set to grow to £1,030,000 to match Consumer Price Index inflation.
What are the different types of ISA?
Remember years ago, when there was only a few crisp flavours and now there are loads? Well the same thing has happened with ISAs.
In the past there was only Ready Salted and Cheese & Onion (Cash and Stocks&Shares). Nowadays, there are lots of new flavours like Sweet Chilli, Fiery Chipolte, White Stilton and Apricot (Junior, Innovative Finance, Lifetime, Help to Buy). Although despite this, most people still get Ready Salted and Cheese & Onion.
The Cash ISA
The most common type of ISA is the cash ISA. This is simply a savings account with the tax benefits mentioned earlier. Whilst this can be a good place to hold money, interest rates are very low and the majority of people won’t pay tax on their savings now due to the Personal Savings Allowance (and savings rates being offered being very low compared to historical data).
Your capital (AKA the money you put in) is also safest* in a cash ISA rather than any of the other options (Without getting too technical, all money is at some level of risk so cannot be said to be 100% safe).
Stocks and Shares ISA
A Stocks and Shares ISA are accounts where your money is invested can be invested in an almost infinite number of ways into different companies, different stock markets and different investment funds.
The key difference here is that your money is at risk and could be lost. Because of this risk, the potential rewards with a Stocks and Shares ISA are bigger and over a long period of time, this type of ISA would be expected to outperform a Cash ISA.
A couple of points to note about a Stocks and Shares ISA:
- Although it mentions Shares in the title, investing all of your ISA into shares of just one company is seen as a bad idea as it doesn’t give you the diversification you need (Don’t put all your eggs into one basket).
- When picking a Stocks and Shares ISA, you will be charged ongoing fees. Whilst you shouldn’t let these fees put you off, you also should make sure these are low.
Innovative Finance ISA
The Innovative Finance ISA is where the money you put into an ISA is loaned via Peer to Peer lenders like Zopa to other people and businesses and in theory you receive your money back plus some of the interest paid by the people.
The rates on offer are usually pretty good and your money is split across lots of people so that if any don’t pay (bad debt), it shouldn’t have too much impact on your returns.
All sound good? Great….. However Innovative Finance ISAs are new and the whole Peer to Peer lending market is relatively new. This BBC article from 2016, articulates some of the benefits but also risks with the Innovative Finance ISA.
Help to Buy ISA
Put your money in to a Help to Buy ISA and the government will put in some free money for you. A great idea but they will only give you the money if you meet certain conditions (mainly to do with buying a house). As this is a website about retiring rather than buying a house, if you are interested in this I suggest a Google.
However, a Lifetime ISA is a bit different…
Tell me more about the Lifetime ISA
A Lifetime ISA is an account that helps you to save for either your first house or for later life/retirement. The big news with a Lifetime ISA is that the Government give you free money (yes, really) when you put money into a Lifetime ISA.
Here are the key bullet points:
- You have to be under 40 (and over 18) to open a Lifetime ISA
- You can only pay into the Lifetime ISA until you are 50
- Money you pay into a Lifetime ISA will get a 25% bonus from the Government up to a maximum of £1000 a year.
- AKA you put in £4,000 but once the government top it up you have £5,000
- There are various restrictions about buying a house (see here for more details on this)
- If you want to use the Lifetime ISA to help with retirement savings, you can’t access it until you are 60.
- If you do access the money before, you are charged a 25% penalty on the whole Lifetime ISA pot
- This is bad news as you would lose more than what the Government gave you in the first place. If you think this could happen then you should possibly rule out a Lifetime ISA.
- Any money in a Lifetime ISA uses some of your £20k ISA allowance.
- The money in a Lifetime ISA can be held like a Cash ISA or invested like a Stocks and Shares ISA.
I don’t want to risk losing any money, can I invest in an ISA?
Yes, although you will need to stick with a cash ISA. These aren’t the best, but it is better than under your bed.
Where can I get an ISA?
All banks and building societies will offer a cash ISA. If you want a stocks and shares ISA, Money Saving Expert have a guide to some of the cheapest (not necessarily the best) providers:
Can I use an ISA to give me a monthly income in retirement?
Yes, if you have enough money in an ISA* you could either withdraw money from an ISA slowly (possibly living off the interest of a Cash ISA and slowly eroding the pot) or you could live off the dividends and interest accumulated in the Stocks and Shares ISA (again possibly slowly eroding the pot).
*How much money you will need will depend on your individual circumstances and you will want to ensure you never run out of money (This is the point where you need to speak to a Financial Adviser)
What are ISA millionaires? Could I become one?
ISA millionaires are people who have carefully invested/maximised their ISA allowances and left the money in the ISA account over a long period (where it can benefit from compound interest) so that the money they now hold within ISAs exceeds £1m.
This is clearly a great position to be in. If you have £1m in an ISA, it is possible you could withdraw £20k a year completely tax free each year and are likely* still have £1m in the pot at the end of the year. *not guaranteed though.
With the allowances at £20k, more and more people will become ISA millionaires in the coming years. The important things to notes here are:
- Most ISA millionaires, will have put their money in Stocks and Shares ISAs rather than Cash ISAs
- They have kept their money locked away and benefited from compound interest.
- They have invested regularly into ISAs for a sustained period.
Can I access an ISA before I retire?
Yes, unlike Pensions which are locked away until you are at least 55, ISA’s can be accessed earlier. Please note, however that some ISAs can penalise you if you withdraw early (particularly the Lifetime ISA).
ISAs are great, although they have some restrictions, the tax benefits once you put money into an ISA are hard to beat. However, in terms of saving for retirement, Pensions are (in most circumstances) even better due to the support of your employer and the Government.
Using both ISAs and Pensions as part of your retirement planning may be a sensible strategy.
Need more information?
Below are some of the links that you may find useful when researching ISAs for retirement:
Lifetime ISA explained by the Government: https://www.gov.uk/lifetime-isa
Concerns about Innovative Finance ISA: http://www.bbc.co.uk/news/business-35881629
None of the above is financial advice, it is general information. Do your research and tread carefully!