ISA (individual savings account) allowance: £20,000 for 2018/19
The ISA allowance is probably the most commonly used form of tax-relieved savings. ISAs can hold cash, investments or a combination of both; they’re advantageous because the income they produce is free of income tax; and when you sell investments held in an ISA, gains are free of capital gains.
We advise clients to use ISAs to grow their savings while they’re still earning and then benefit from the tax-free income once they hit retirement age. However, ISAs can be used throughout working life to invest lump sums or make regular savings because savings held in an ISA can be accessed at any time.
At this time of year, it’s common for banks and building societies to start advertising the availability of the ISA allowance, in an attempt to entice investors to put money into their cash ISAs. We don’t think there’s any real benefit in using your ISA allowance to subscribe to a cash ISA, unless you hold a great deal of your savings in cash. This is because since April 2016, the first £1,000 of interest on cash is tax-free if you are a basic rate taxpayer (it’s £500 if you pay higher rate tax). It’s also extremely rare to find a cash ISA that offers a rate of interest higher than the current inflation rate – and if inflation is higher than the interest paid on your cash savings, their value is eroded.
At present, you’d need cash savings of around £100,000 to produce £1,000 annual interest. If you happen to have this much spare cash, it’s likely that investing in a stocks & shares ISA will be more beneficial.
Pension allowance: the lower of 100% of earnings or £40,000 for 2018/19**
There are so many advantages to pension savings that it would take a whole new blog to explain them (watch this space!). The main advantage – other than building a fund for your retirement – is that personal pension contributions attract tax relief. HMRC will automatically add 20% of your contribution to your pension fund; so if you contribute £200 every month, HMRC automatically deposits an additional £50 in your pension fund. This tax relief is increased to 40% for higher rate taxpayers, who receive an additional 20% tax relief via an adjustment to their tax code or a tax refund.
Like ISAs, funds within a pension grow free of tax. However only 25% of the fund can be withdrawn tax-free and you must be aged 55 or over in order to access the fund. In the past retirees had little choice but to take the 25% lump sum and - at the same time - start taking a regular taxable income from the other 75% of the fund. A lot has changed in recent years, especially with the introduction of the Pensions freedoms in April 2015. Now there are multiple ways of accessing a pension fund.
The annual pension allowance includes contributions to a pension made by an employer; so if you’re thinking of using your pension allowance, it’s always a good idea to check the amount your employer is contributing. There’s also a lifetime limit on the total amount of pension saving (it’s £1,030,000 for 2018/19); so if you’re lucky enough to be in a situation where you can maximise your contributions, you’ll need to keep an eye on the value of your pension as you approach retirement.
**It’s still possible for an individual to make pension contributions if they have no earned income, but their annual allowance is limited to £3,600. It should also be noted that pension rules are very fluid and liable to change, especially when a government is looking to earn the support of older voters. So while these limits are correct for 2018/19, it’s very likely that the pensions goalposts will be moved again in the near future. We as advisors ensure that we’re up to speed with the ever-changing world of pensions so we can help pension savers avoid heavy tax bills caused by ignorance of the effect of changes.
Lifetime ISA allowance: £4,000 for 2018/19
Known as the ISA that thinks it’s a pension, the Lifetime ISA (or LISA) was introduced in April 2017; it’s aimed at encouraging young people to save for their future. It seems to offer the best features of pensions and ISAs with a 25% government bonus on contributions and tax-free withdrawals. However there are a number of conditions that mean that LISA might not be the most suitable savings vehicle.
The most obvious drawback to LISAs is that they are only available to 18-39 year olds and contributions must stop at age 50. If you’re a LISA investor you can only access the fund tax free if you’re withdrawing it to buy a house or after you turn 60. If you choose to withdraw the fund at any other time, HMRC claws back its 25% contribution bonus AND the investment growth on it. Also, only £4,000 a year of the £20,000 annual ISA allowance (£3,000 of your money plus the £1,000 government bonus) can be invested in a LISA. The pros and cons of LISA savings need to be taken into account, especially if you’re choosing between a LISA and a pension.
The LISA is a close relative of the Help To Buy ISA, which works in much the same way although the amount you can invest in a HTB ISA is limited to £2,400 a year. The HTB ISA is only available to first time buyers but the fund can be withdrawn at any time and for any purpose, although the government bonus won’t be applied if it’s not used to buy a house.
This guide is far from comprehensive and as such, it shouldn’t be used as an instruction manual. It’s designed to explain the opportunities available for your money. If you’d like more information about the investment allowances available to you in 2018/19 and to discuss the most suitable investments for your circumstances, please get in touch.